You’ve probably heard market analysts refer to P/E ratio before, but what is it? That’s a good question that Tom and Brendan answer during this week’s Mullooly Asset Management podcast. They define the term and also give examples that will make it simpler for individuals to understand.
P/E (or price to earnings ratio) ratio measures the multiple that a stock is selling at. By comparing a stock’s P/E ration to the market’s P/E ratio you can try to determine if a stock is cheap or expensive. P/E ratio will vary depending on the industry you’re examining. One thing to keep in mind is that P/E value does not change when the stock splits. To put it in numeric terms, if a stock is trading at $75 per share and has earnings of $7.50 per share its P/E ratio is 10. For more numeric examples regarding P/E ratio feel free to check out this useful article (http://www.investopedia.com/articles/fundamental-analysis/09/price-to-earnings-and-growth-ratios.asp).
Historically, a stock with a P/E ratio of 20X or more is considered a high growth stock. A stock with a P/E ratio of 2-4x is a value stock. In terms of the overall market, when the P/E ratio is 12x or less the market is considered cheap. When the P/E ratio is 15x or more, the market is considered expensive.
While P/E ratio can be a useful tool, one thing that can cause some confusion is when difficulties arise in identifying which industry a specific stock is a part of. Tom and Brendan give some examples of situations like this in the podcast. One example they discuss is Amazon. They’re considered to be an internet company, but they are also a retailer. Internet stocks and retailers traditionally have very opposite P/E ratios. So what multiple would you expect Amazon to trade at? Using P/E ratio can be a little trickier than it seems.
Make sure to tune into this week’s podcast to hear the full explanation from Tom and Brendan. You’ll also get to hear some more examples of P/E ratio too.