What is P/E ratio?

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Here is another important Fundamental analysis that one can use in gauging a stock.

Price earnings ratio or commonly known as P/E ratio is a valuation ratio. A simple computation is dividing the market price per share by EPS per share or dividing market capitalization by net income. P/E ratio is an indicative of how the market or investors value the stock. A higher P/E ratio means the investing market is willing to pay for such stock that number of times for its earnings. It indicates that the perceived expectation of the market is that the company will perform well thus they are willing to pay more for it.

Knowing the P/E ratio gives you two information when you use it to compare stock buys. Stocks with higher P/E ratio are stocks that are probably believed by the market as profitable in the long run and the second is if comparing stocks with the same level it indicates which stock is overpriced.

For example Company A has a P/E ratio of 18 while Company B has 6, this indicates that Company A is perceived by the market as having more profit generating capability than Company B. But upon looking closely when such two companies have the same EPS it only means that Company A is over priced as compared to company B.

About the blogger

Louis Delos Angeles is a Certified Public Accountant, blogger behind Investing in Philippines, and author of Investing in Stocks: Preparing for the future small amount at a time. Check him out in Google+ Learn more about Louis and his financial freedom advocacy here.

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