Course 108: Learn the LingoBasic Ratios  
Price/Earnings and Related Ratios  

One of the most popular valuation measures is the price/earnings ratio, or P/E. The P/E is the price of a stock divided by its EPS from the trailing four quarters. As an example, a stock trading for $15 per share with earnings of $1 per share during the past year has a P/E of 15. P/E = (Stock Price) / EPS = The P/E ratio gives a rough idea of the price investors are paying for a stock relative to its underlying earnings. It is a quick and dirty way to gauge how cheap or expensive a stock may be. Generally, the higher the P/E ratio, the more investors are willing to pay for a dollar's worth of earnings from a company. High P/E stocks (typically those with a P/E above 30) tend to have higher growth rates and/or the expectation of a profit turnaround. Meanwhile, low P/E stocks (typically those with a P/E below 15) tend to have slower growth and/or lesser future prospects. The P/E ratio can also be useful when compared with the P/Es of similar One useful variant of P/E is earnings yield, or EPS divided by the stock price. Earnings yield is the inverse of P/E, so a high earnings yield indicates a relatively inexpensive stock while a low earnings yield indicates a more expensive one. It can be useful to compare earnings yields with 10 or 30year Treasury bond yields to get an idea of how expensive a stock is. Earnings Yield = 1 / (P/E ratio) = EPS / (Stock Price) Another useful variant of P/E is the PEG ratio. A high P/E generally means that the market expects the company to grow its profits rapidly in the future, so a much greater percentage of the company's potential earnings are in the future. This means its market value (which reflects those future earnings) is large relative to its presentday earnings. The PEG ratio can help you determine if a stock's P/E has gotten too high in these cases by giving you an idea of how much investors are paying for a company's growth. A stock's PEG ratio is its forward P/E divided by its expected earnings growth over the next five years as predicted by a consensus of Wall Street estimates. For example, if a company has a forward P/E of 20 with annual earnings estimated to grow 10% per year on average, its peg ratio is 2.0. Again, the higher the peg ratio, the more relatively expensive a stock is. PEG = (Forward P/E Ratio) / (5Year EPS Growth Rate) As with other measures, the PEG ratio should be used with caution. PEG relies on two different Wall Street analyst estimatesnext year's earnings and fiveyear earnings growthand thus is doubly subject to the possibility of overly optimistic or pessimistic analysts. It also breaks down at the extremes of zerogrowth or hypergrowth companies. Next: Price/Sales Ratio >> 
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