'Education'

Price Per Earnings Ratio (P/E)


The price per earnings ratio (P/E) can be very helpful in judging the valuation (how cheap a stock price is).
Basically, what the P/E tells you is how many years worth of current earnings it would take for the company to earn your share price. PE ratio = Share Price/Earnings per share (EPS). If the share price is $10 for a company making 50 cents per share, its P/E ration would be 20.
What is a fair P/E ratio for a stock?
It depends upon the growth rate of a company. If their earnings are steady, 10-12 EPS is acceptable. If they are growing, 15-20 is acceptable. Any company with a large growth rate can warrant up to 40+. Google currently has a 38 P/E ratio because they are expected to grow their EPS about 25% this year.
There is no exact formula showing what a fair P/E ratio is, but this seems to work well.


Earnings Per Share (EPS)


Earnings per share or EPS is the way an investor knows how much money a company is making with their money. How the EPS is determined, is by taking the number of shares outstanding, and dividing it by the amount of profit that a company makes during a specific period of time (usually a quarter or year).
EPS= Outstanding shares/profit
If a company lost money after taking expenses, they can end up with a negative EPS. Many new companies start with a negative EPS, and work their way to toward profitability.


Exchange-Traded Funds (ETFs)


Exchange Traded Funds or ETFs are an investment option that trades like a stock, but operates like a mutual fund.  A lot of them follow an index (called an index fund) like the S&P 500, Dow Jones Industrial Average, or the Russell 1000.  These trade almost exactly with the index (If the S&P 500 goes up 2%, so will SPY, the S&P index fund).

The benefits:

-        Instant diversification.  Your money is split evenly between hundreds of individual stocks.

-        Low costs.  When you invest in an ETF, you avoid paying a lot of fees to fund managers and trade fees.

-        Do better than most mutual funds.  A majority of mutual funds do not even beat the market average.

-        No brainer.  There is not much research to be done.

The drawbacks:

-        Bad stocks.  When you buy the index fund, you are forced to invest in poorly run companies (GE, GM, etc.)  You have no choice but take them all.

-        Over-diversification.   I like to invest in less than 10 quality stocks so I can get the full benefits of gains.  If I have 10 stocks, and one goes up 10%, my account is up 1% from that move.  If I have 500 stocks and one goes up 50%, I am only up 0.1% for that move.