Extracting Value: Value Investing Resource

PE this and PE that. Are we back in elementary school playing kickball?

Nope, we’re talking about investing and a ratio that is a decent marker for how expensive a stock is based on only a few piece of data. Those data are the price of the stock per share and the annual earnings of the stock per share. When you divide the price by the earnings, you get the PE ratio.

PE = Price per Share / Earnings per Share

So what does the PE ratio tell you? It tells you how many years it would take you to get your money back if the earnings keep up as they are. (Of course that is, if the company were to fully retain earnings, or give them all back to the shareholders.)

Growth stocks usually have high PE ratios between 20 and 30. This accounts for all the growth that you’re buying the stock for. For value stocks, these can range greatly. However, if you look into a value stock and see that the price of the stock based on book value is low, say 1 – 2 times the book value, and the PE ratio is low, say 5 – 10, then you may be onto a stock that could prove a value investment.

The PE ratio needs to be taken into account with many many other ratios but it can be a good indicator of how cheap a stock really is based on the earnings of that stock.