The P/E Ratio: Finding a Bargain-Priced Stock
There are potentially dozens of indicators and ratios you can use to study the financial statements of a company. For the purpose of creating a basic starting point, focus here is on a very short list of fundamental indicators. These can be based strictly on the financial information you extract from the financial statements or, in one important exception, may combine financial and technical sides. This one exception is the price/earnings ratio (P/E). This is a comparison between the price per share and the reported earnings per share (EPS) reported most recently by the company.
The P/E ratio is a good place to start in exploring a range of fundamental indicators because it combines technical (price) with fundamental (earnings), and also because it matches dissimilar timing indicators.
Key PointThe P/E ratio combines technical (price) and fundamental (earnings) information to create a hybrid indicator.
Justification for the forward P/E is that it makes the indicator more current. However, a lot of change can take place in the future, and as an indicator of stock value, forward P/E is not a reliable one. Any indicator that includes estimates should be used only cautiously.
Key PointThe forward P/E is a diffi cult indicator to rely upon, because it uses estimates in place of published results. The historical P/E is more reliable, when studied over a 10-year period.
In calculating the historical P/E, the current share price is divided by the latest reported EPS, or earnings per share:
Tracking the P/E range for a 10-year period demonstrates how the historical range of P/E from highest to lowest per year helps to find price and value stability. In Figure below, the 10-year high and low P/E for General Mills (GIS) is summarized.
[caption id="attachment_12692" align="aligncenter" width="550"]P/E ratio, 10 years: General Mills (GIS)." src="http://img.investorguide.com/article/wp-content/uploads/2013/04/nfg0018.jpg" width="550" height="444" /> P/E ratio, 10 years: General Mills (GIS).[/caption]