INVESTORS USE PRICE/EARNINGS RATIOS TO PICK STOCKS
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The price/earnings ratio is the tool most commonly used to help
investors value stocks. Calculated by dividing a firm?s per-share market price
by its earnings per share, the P/E ratio can identify some attractive buys and
eliminate some overpriced stocks from your consideration.
One caveat: although the formula is very simple to calculate,
there are many factors that influence either a firm?s earnings or its stock
price. It is very important to do a thorough analysis of these two components
before relying on the P/E ratio. Once you have an accurate P/E ratio for a firm,
it is always a good idea to compare it to those of competitors and the
price/earnings ratio of the overall market.
If you are interested in learning more about this topic as
well as other topics regarding security selection, please consult the other
tutorials in this series. Click here to learn even more about this topic with the Encyclopedia of Personal Finance™