Moneywise24 Personal Finance

I know, most of you would have expected me to dig into the financials of a company first. However, I have explicitly chosen to write the first article on fundamental stock analysis about the P/E ratio. The P/E ratio stands for Price-to-Earnings Ratio, and might is also referred to as PER.

The P/E ratio measures the price paid per share relative to the earnings on that share, or the Earnings Per Share. The P/E ratio is expressed in years. As such, having a P/E ratio of 8 means that if I would buy 1 share, it would take me 8 years to earn back my investments on that share; A P/E ratio of 30 means that if I would buy 1 share, it would take me 30 years to earn back my investments on that share. Thus, the formula is:

P/E ratio = Price per Share / Annual Earnings per Share

The P/E Ratio can also be expressed in percent:

• A P/E ratio of 8 resembles an annual return 12.5% (becuase 8 times 12.5% is 100%),
• A P/E ratio of 30 resembles an annual return of 3.33%.

From the above examples, it is easy to conclude that a lower P/E ratio means higher annual returns. However, since the Earnings Per Share is related to the actual income of a company, it also makes a statement as to whether the share is relatively inexpensive or expensive considering the company’s current economical situation. Generally said:

• Share with a P/E ratio below 10 is considered as inexpensive,
• Sahre with a P/E ratio above 20 is considered as expensive.

P/E ratios should never be considered alone, but always in the context of the performance of the company. One reason the P/E ratio of a company is low might be simply due to the fact that the company has been somewhat ‘forgotten’, although the company is performing well. However, another reason might be, because the company’s performance is very poor and investors have been selling the shares massively.

Some internet platforms offer the possibility to select shares according their P/E ratio, such as Yahoo! Finance; this allows you to select the more inexpensive shares, and work from there. But you will definitely want to conduct further research as to the company’s future.