What is a P/E Ratio
and Why Should I Care?
Allen Holdsworth
Illowa Buy States Chapter
BIVA Board Director
Classes-To-Go
BETTERINVESTING NATIONAL CONVENTION
Disclaimer
•
The information in this presentation is for educational purposes only and is not
intended to be a recommendation to purchase or sell any of the stocks, mutual funds,
or other securities that may be referenced. The securities of companies referenced
or featured in the seminar materials are for illustrative purposes only and are not to
be considered endorsed or recommended for purchase or sale by BetterInvesting™
National Association of Investors Corporation (“BI”) or the BetterInvesting Volunteer
Advisory Board, its volunteer advisory board (“BIVAB”). The views expressed are
those of the instructors, commentators, guests and participants, as the case may be,
and do not necessarily represent those of BetterInvesting™ or BIVAB. Investors
should conduct their own review and analysis of any company of interest before
making an investment decision.
•
Securities discussed may be held by the instructors in their own personal portfolios or
in those of their clients. BI presenters and volunteers are held to a strict code of
conduct that precludes benefiting financially from educational presentations or public
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the President of BetterInvesting or the Manager of Volunteer Relations.
BETTERINVESTING NATIONAL CONVENTION
Understanding P/E Ratios
• Presented by:
• Allen Holdsworth
• Illowa Buy States ChapterDirector
• BIVA Board-Director
• Teach 16 week Personal Investing
class at community college
BETTERINVESTING NATIONAL CONVENTION
What is a P/E Ratio?
• It is NOT gym class
• No need to get all sweaty
• You can figure out P/E ratios even
if you can’t walk and chew gum at
the same time!
BETTERINVESTING NATIONAL CONVENTION
What is the P/E Ratio?
• The P/E ratio is the price per
share of stock divided by the
earnings per share of stock
• The question is - which earnings
are used?
BETTERINVESTING NATIONAL CONVENTION
Understanding P/E Ratios
• P/E Ratio means:
• Price per share divided by the
earnings per share from the last 4
quarters
• This is the trailing P/E
• Price changes every day
• Earnings per share only changes
each quarter
BETTERINVESTING NATIONAL CONVENTION
Understanding P/E Ratios
• Value Line uses current P/E--Use
the last 2 quarters plus the next 2
quarters in the future
• Future P/E uses the projected
earnings over some future time
period
BETTERINVESTING NATIONAL CONVENTION
P/E Ratios
• The P/E ratio is the amount of
money someone is willing to pay
to get $1 of earnings
• It could be considered a
popularity contest
• In general - the faster a company
is growing, the higher the P/E it
will have
BETTERINVESTING NATIONAL CONVENTION
P/E Ratios
• What makes the P/E change?
• The future growth prospects are
the driving force in price and P/E
BETTERINVESTING NATIONAL CONVENTION
P/E Ratios
• What is a good P/E or a bad P/E
• Is a P/E of 20 good or bad?
• It depends!!!!
– Look at past history of P/E ratios
– Look at other companies in same
industry
– Look at average P/E for S&P 500
– Look at the prospects for the
company
BETTERINVESTING NATIONAL CONVENTION
P/E Ratios
• In general, the faster a company
grows - the higher the P/E ratio
• As the growth of a company slows
over time - the P/E ratios will
usually come down
BETTERINVESTING NATIONAL CONVENTION
P/E Ratios
• Different types of industries tend
to have different P/Es - even if the
growth rates are similar
• Part 3 of the Stock Selection
Guide helps us determine the
normal range of high and low P/E
BETTERINVESTING NATIONAL CONVENTION
P/E Ratios- Pulte Homes
BETTERINVESTING NATIONAL CONVENTION
P/E Ratios-BUD
BETTERINVESTING NATIONAL CONVENTION
P/E Ratios- BBBY
BETTERINVESTING NATIONAL CONVENTION
Section 3- Apple Computer
BETTERINVESTING NATIONAL CONVENTION
XM-How do you make an
estimate?
BETTERINVESTING NATIONAL CONVENTION
P/E Ratios in Section 3
• Eliminate outliers - can see the
last 10 years of P/Es on Toolkitclick on avg. high or avg. low P/E
box in Section 3
• P/E expanding - use average
• P/E shrinking - use most recent or
even lower
• Max. high P/E of 30 (1.5 times
growth rate or sometimes 2 times
BETTERINVESTING NATIONAL CONVENTION
P/E Ratios
• Don’t buy a stock just because the
P/E ratio is low
• Do more research - try to discover
why it is low
• There may be bad news and it
deserves to be low
• The future growth prospects are
the real driving force
BETTERINVESTING NATIONAL CONVENTION
P/E Ratios
• There are 7 basic ways a
company can increase earnings
–
–
–
–
–
–
–
Reduce costs
Raise prices
Open more stores/expand
Sell more in existing markets
Fix or sell losing operations
Buy back shares
Lower taxes paid
BETTERINVESTING NATIONAL CONVENTION
Understanding P/E Ratios
• References: from BetterInvesting:
– Stock Selection Handbook
– Using Portfolio Management Wisdom
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