P/E Ratio and Stocks

[mime]

How important do you consider the P/E Ratio when buying stocks?

I think it really helps to judge the stocks value and I always take it into consideration.

 

[Fleeta]

Problem with P/E is that it is a retrospective look at earnings - you should use prospective P/E, but that figure is often rubbery...so its not always that easy, but it is a useful indicator, provided earnings aren't too volatile.

Also, how do you use it for a company that made a loss last year, but is growing fast and is expected to make money soon?

I rather use dividend yield...Companies like to keep their dividend yield pretty steady, and have the power to do so, unlike earnings which they cannot control (to a certain extent, i've seen some good earnings management in the past).

 

[ramjet]

What do you do when companies borrow to pay dividends?

 

[Smurf1976]

I would certainly be looking at the P/E if I were trying to forecast the overall direction of the market indices.

These figures are American but I assume they would broadly apply to Australia. In rough figures, around 14 is "normal". 7 or 8 is a typical bear market bottom, 21 is typical of a top. Anything over 28 is official bubble territory.

 

[mime]

These figures are American but I assume they would broadly apply to Australia. In rough figures, around 14 is "normal". 7 or 8 is a typical bear market bottom, 21 is typical of a top. Anything over 28 is official bubble territory.

Does that mean WPL is in trouble?

 

[Smurf1976]

Does that mean WPL is in trouble?

Not on this basis. WPL's earnings would have increased greatly due to the surging oil price so any analysis based on earnings over a prior period would not give an accurate picture.

Of course, if the oil price goes down a lot then I wouldn't want to be holding WPL but that is another story.

Also, the figures apply to market indices and blue chip industrial stocks with relatively stable earnings, a category into which WPL doesn't fit given exposure to volatile oil prices.

A note on timing too. An overvalued market can of course become more over valued before it corrects and vice versa.

The one thing that really does worry me though is that the major US indices never did see a true bear market bottom valuation after the 2000 bubble peak. On that basis I wouldn't use any blind "buy and hold" strategies whereas if we had a decade plus bear market ending at a P/E of 7 then I would consider placing a portion of my funds into such a strategy. Early 1982 would have been a good time to do that, selling in 2000 when the bubble started to deflate. (I'm talking about the US markets here).

 

[emily]

umm i dont quite understand how the p/e ratio works.....
the p/e ratio indicates market confidence in the company's future prospects,
so the higher the ratio the better right ?



thnx,
emilyz

 

[Caliente]

Hi, maybe this will help.

"
Financial ratios
Value investing can be defined as investing in companies with high cash flow, low P/E, low p/e/g, low p/b ratios, among other things. In particular value investors have long considered the price earnings ratio (p/e ratio for short) a useful measure of the relative attractiveness of a company's stock price. The price /earning ratio is the price an investor is paying for the company's earnings. In other words, if a company is reporting earnings per share of $2 and it’s selling for $20 per share, the p/e ratio is 10 ($20 per share divided by $2 earnings per share = 10 p/e.) Made popular by the late Benjamin Graham, Warren Buffett etc, Graham preached the virtues of this financial ratio as one of the quickest and easiest ways to determine if a stock is trading on an investment or speculative basis. Like to know more read the definitive book on the subject, Value Investing: From Graham to Buffett and Beyond."

source: http://www.asx.com.au/resources/newsletters/investor_update/20041012_ValueInvesting_IE3.htm

 

[Fleeta]

umm i dont quite understand how the p/e ratio works.....
the p/e ratio indicates market confidence in the company's future prospects,
so the higher the ratio the better right ?



thnx,
emilyz

Em, you just blew my mind because I never thought of it that way...and you are not wrong.

However, I always look for value and say that the lower the P/E the better. A company might have a high P/E for a number of reasons. For me, I think the main 2 are that either its earnings have fallen (bad sign), or its share price has grown too fast (also bad sign). A low P/E on the other hand could signal an undervalued share, or one whose earnings have jumped without the market 'noticing' if thats possible.

The problem is that often low p/e stocks are just plain out of favour with the market and even though their earnings are going well, the share price is stuck going nowhere. An example of this is BPC, who is loaded with debt and despite a low p/e is not experiencing share price growth.

 

[It's Snake Pliskin]

Does that mean WPL is in trouble?

Personally, I think WPL is way over priced. It's production is not that high, though it's price has risen dramatically in a short time and may not be indicative of the future. The price of oil has added a lot to earnings, but....

 

[emily]

oh thanx Caliente and fleeta,
i was thinking the same as ya fleeta...........=)

 

[emily]

ummm what hapens if theres a negative p/e ratio, is that good or bad ?


emily =)

 

[bvbfan]

Negative PE means you have negative earnings as you cant have a negative price

So the company is unprofitable at the moment so usually it would be a bad thing, but may need to look at why the earnings was negative (FX translation , writedowns etc)