Price/Earnings Ratios

P/E Ratios are relative to different sorts of stocks. Generally speaking a P/E below 10 says that the stock is cheap and one over 30 says it is expensive. However, you can have a very high P/E on a fast growing stock and make lots of money when the stock has momentum.

The P/E Ratio I use in my stock tests is the forward P/E Ratio. That is I am using the EPS estimates to calculate the P/E Ratio. I compare this P/E Ratio to the 5 year low, median and high median P/E Ratios I have in my spreadsheet for a particular stock.

That is I look at the 5 year median P/E Ratio for the stock price lows over the past five years, the 5 year median P/E Ratio for the stock price highs over the past 5 years and the 5 year median P/E Ratios for the stock price average between the stock highs and lows stock prices.

When I look to see if a stock price is good or not, yes, I use the P/E Ratio. However, I also try to use at least 3 other stock price tests. This would include generally include looking at the Price/Graham price Ratios, the dividend yield, and the Price/Book Value per Share Ratio. If for some reason I cannot use one of the above there are also Price/CFPS Ratio and the Price/Sales Ratio.

What you generally get for each year for stock prices is the stock price high, low and the close prices. The highs are the highest stock price reached in the year. The lows are the lowest stock price reached in the year. The median or average price is the value between the high and low prices for a year. (I calculate this value.) These are generally all close prices. The close price is the last price for a particular day or period. For example, the highest price reached in a year is generally a day end close price.

Generally, stock charts show the close price per day over a period of time, if the period is 1 month or more. If the time period is say more than 10 years, a lot of stock charts just show the close price for each week or each month in the applicable period. If say a stock price on a chart is dated January 31, 2014, what you generally get is the close price for the day of January 31, 2014.

Further reading would be in Investopedia and Wikipedia. It is interesting that Investopedia thinks that a 20-25 P/E Ratio is an average one whereas Wikipedia thinks that a P/E Ratio of 17 to 25 is high. The About.com site also has an article on P/E Ratios. If you like video, you can learn about P/E Ratios on YouTube.

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This blog is meant for educational purposes only, and is not to provide investment advice. Before making any investment decision, you should always do your own research or consult an investment professional. See my site for an index to these blog entries and for stocks followed. Follow me on Twitter.