What have we learned about the P/E ratio? Although the P/E often doesn't tell us much, it can be useful to compare the P/E of one company to another in the same industry, to the market in general, or to the company's own historical P/E ratios.
Some points to remember:
- The P/E ratio is the current stock price of a company divided by its earnings per share (EPS).
- Variations exist using trailing EPS, forward EPS, or an average of the two.
- Historically, the average P/E ratio in the market has been around 15-25.
- Theoretically, a stock's P/E tells us how much investors are willing to pay per dollar of earnings.
- A better interpretation of the P/E ratio is to see it as a reflection of the market's optimism concerning a firm's growth prospects.
- The P/E ratio is a much better indicator of a stock's value than the market price alone.
- In general, it's difficult to say whether a particular P/E is high or low without taking into account growth rates and the industry.
- Changes in accounting rules as well as differing EPS calculations can make analysis difficult.
- P/E ratios are generally lower during times of high inflation.
- There are many explanations as to why a company has a low P/E.
- Don't base any buy or sell decision on the multiple alone.
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