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Key Points About the P/E Ratio
1. P/E Ratio is a way of expressing how much investors have to pay for the profits a company generates. Mathematically, it is the company's market capitalization (the total cost of buying all of its shares) divided by its earnings (revenue minus expenses). You may also see it expressed as share price divided by earnings per share; either equation will give the same answer.
2. Unless noted otherwise, the P/E ratio measures earnings over the past trailing 12 months.The price is typically taken either in real-time or the most recent daily close price.
3. The P/E ratio is criticized by some for looking at past earnings, when the real factor that may drvie stock price is future earnings. As such, some investors focus on the forward P/E ratio. The forward P/E ratio takes today's price and divides it by estimates for earnings over the next 12 months. These estimates can be the average estimate of analysts covering the stock, or it can be the company's own estimate of its earnings in the year ahead. Either way, forecasted earnings are often imprecise, and thus while the may have the advantage of being forward looking, they have the disadvantage of being prone to error.
4. A criticism of both trailing twelve month (TTM) P/E ratio and the forward P/E ratio is that the 12 month data sample is too small -- regardless of whether we are looking forward or backward. The Shiller CAPE ratio was thus devised; it looks at the average inflation-adjusted earnings over the past 10 years. The Shiller CAPE ratio cannot really be applied to companies with less than 10 years of positive earnings data. It is typically used when valuing indices, where it's ability to account for market cycles, differing interest rate environments, and long-term trends are more valued.
5. Critics of the P/E ratio say it is useless, citing its complete lack of corelation with its underlying stock. Advocates suggest it can be useful as an indicator of sentiment; when P/E ratios are at historic lows, it can be a good buying opportunity, and when they are well above average, it can be a time to sell or at least not further accumulate. Advocates believe there is a mean reversion principle to the P/E ratio.
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Key Points About the P/E Ratio
1. P/E Ratio is a way of expressing how much investors have to pay for the profits a company generates. Mathematically, it is the company's market capitalization (the total cost of buying all of its shares) divided by its earnings (revenue minus expenses). You may also see it expressed as share price divided by earnings per share; either equation will give the same answer.
2. Unless noted otherwise, the P/E ratio measures earnings over the past trailing 12 months.The price is typically taken either in real-time or the most recent daily close price.
3. The P/E ratio is criticized by some for looking at past earnings, when the real factor that may drvie stock price is future earnings. As such, some investors focus on the forward P/E ratio. The forward P/E ratio takes today's price and divides it by estimates for earnings over the next 12 months. These estimates can be the average estimate of analysts covering the stock, or it can be the company's own estimate of its earnings in the year ahead. Either way, forecasted earnings are often imprecise, and thus while the may have the advantage of being forward looking, they have the disadvantage of being prone to error.
4. A criticism of both trailing twelve month (TTM) P/E ratio and the forward P/E ratio is that the 12 month data sample is too small -- regardless of whether we are looking forward or backward. The Shiller CAPE ratio was thus devised; it looks at the average inflation-adjusted earnings over the past 10 years. The Shiller CAPE ratio cannot really be applied to companies with less than 10 years of positive earnings data. It is typically used when valuing indices, where it's ability to account for market cycles, differing interest rate environments, and long-term trends are more valued.
5. Critics of the P/E ratio say it is useless, citing its complete lack of corelation with its underlying stock. Advocates suggest it can be useful as an indicator of sentiment; when P/E ratios are at historic lows, it can be a good buying opportunity, and when they are well above average, it can be a time to sell or at least not further accumulate. Advocates believe there is a mean reversion principle to the P/E ratio.
Read More....