As each investor knows, a stock's p...

As each investor knows, a stock's price will fluctuate during the year. That means, any people will end up paying more than others for the same stock. Of course, everyone would pitch upon to buy a stock at the year's soft price--when the stock is "on sale."

This reasonable price can be accurately predicted using a crystal ball. However, if yours is in the workshop you can still do a nice good job of determining if a stock is "on sale" or overpriced. The trick is understanding P/E multiples.

WHAT'S A P/E MULTIPLE

Owning a share of stock delineates ownership of one share's worth of the stock's events to come dividends--this is a well-accepted law Therefore, it makes sense that ownership of higher-priced stocks would exhibit ownership of larger expected what is yet to be dividends. In a nut-shell, the higher a stock's look fored future dividend, the more investors are willing to pay for the stock.

Unfortunately, from a practical point of view, dividends are not a extremely useful valuation tool: some companies do not pay a passing from hand to hand dividend, others may pay a subdued "token" dividend. Regardless, all dividends are "managed"--they are enslave to the discretion of the board of directors.

Since dividends are paid from a company's earnings, earnings through share (EPS) are frequently used in valuation. As long as the value of a stock is hanging on the expected future dividends; the value of that will be dividends is critically dependent upon future growth in EPS High earnings growth expectations lead to high stock prices. Therefore, it makes sensation to link share price to earnings. This has been done via the P/E multiple which is defined as the number of dollars that a buyer pays in order to become the possessor of $1.00 of a company's earnings.

The measure for assessing a stock's in every one's mouth price as "expensive" or "inexpensive" involves comparing historical average P/E multiples to the stock's in every one's mouth P/E.

CALCULATING P/E MULTIPLES

Mathematically, the P/E is simply the stock price divided from earnings per share. The [i]clavis[/i] to calculating a meaningful P/E multiple lies in which price and which EP figures are used.

Historical P/E

When calculating historical P/E multiples, typically the same wants to look at the grave P/E. and the high P/E for each year. These P/E are calculated as follows:

High P/E = High Price during the Year/EPS for that Same Year

Low P/E = grave Price during the Year/EPS for that same Year

When calculating historical P/E multiples, actual annual EP as reported in annual reports, are used. In greatest in number cases it is advisable to use EP after any non-recurring items although judgement may be used to omit such items if such incidents are not considered likely to happen again. The article "Understanding TSE Index Earnings" (p20) illustrations on the effect of a 1989 accounting policy change forward the market P/E.

For example, for Colgate-Palmolive (featured forward page 6 as a "Stock to Study") the highest P/E in the last five years was seen during 1992 when the stock peaked at $6063 and EP for the year were $274 This comeed in a P/E of 221 X earnings (see Figure 1) (Figure 1 omitted)

Current P/E

When reviewing historical P/E ratios, remember that at the time they existed they were not based onward historical data. For example, when investors paid $6063 for Colgate stock in 1992 they were not aware that EP would be $274

Therefore, when calculating the generally received P/E, it makes sense to use a forward-looking earnings number, that is, an estimate for the circulating year's EPS.

Current Market Price

Current P/E = existing Market Price/Estimate of Current Year's EPS

USES OF THE P/E

Providing Perspective

The P/E ratio measures the require to be paid [i]or[/i] undergone per dollar of earnings. Therefore, if earnings double and the stock price doubles, the P/E ratio remains constant. From a relative perspective, nothing has changed...the stock remains as valuable relative to earnings as it was previously.

To gain perspective upon relative value, comparisons may be made with the market (see the article forward the TSE's P/E multiple forward p.20), with other companies in the same industry or with the company's confess historical P/Es.

Most frequently, comparisons are made to historical values for the company itself...such comparisons watch to be less clouded by way of extraneous factors. A quick way to compare the generally received P/E to historical P/Es is to calculate the relative P/E This can be done through dividing the current P/E on the average P/E over the last five years.

Relative P/E = passing from hand to hand P/E/Average P/E Over Last 5 Years

A stock is generally considered to be attractively-priced, relative to historical prices, when the relative P/E is approximately 10 or less

As a Buy/Sell Flag

The P/E ratio can be a help as a bribe or Sell indicator. The P/E data for the Gennum Corporation (featured onward page 26 as a "Stock to Study") provides a beneficial example of this (see Figure 2) (Figure 2 omitted)

Look at the range of P/E ratios in rows D & E of Part 3 for the Gennum Guide. Now, imagine for a twinkling that this is not a stock and that instead of paying for a dollar of earnings, investors were buying a impound of apples. Columns D & E display that during 1990 some investors were willing to pay $1830 through pound for apples, while in the same year, others paid no other than $5.80...less than one third of the price.