P/E ratio… a value investors first clue. At least for me it is. If the P/E of a company I’m interested in, is not under the industry average, I will not look any further into the company.
The P/E is the price to earnings ratio. If a company’s share price is currently $20 per share, and their most recent earnings were $2 per share, they have a P/E, or price multiple, of 10. The calculation is simple: Share price ÷ earnings per share (EPS).
In general, the lower the P/E, the more undervalued that company might be. If the industry average for P/E is, say, 25, and the company you are interested in has a P/E of 15, then it might be worth a deeper look. Like I said, if a company I am considering does NOT have a lower P/E than their industry has, I will NOT look any further and I will move on.
But, be careful. Some industries, tech for example, have high P/E ratios… in the hundreds. That is because tech companies are growth companies. The P/E ratio is better suited for value companies, not growth. However, recently I purchased some Facebook shares due to their very low P/E when compared to the industry and their competitors.
The P/E, like anything else, should never be used alone. I have found many companies that had low P/E ratios, but did not pan out when I dug in deeper to their financial statements and reports. I simply use the P/E ratio as a starting point. It’s the first place I look.
Always do your own research prior to doing anything financially. If you’re considering a share purchase, I cannot stress enough the importance of researching.