Generally speaking, experts consider a PEG ratio of one or less undervalued, as its price is low compared to its expected future growth. For example, if the trailing P/E ratio of XYZ is 25 and its earnings growth rate for the next five years is 15%, then its PEG ratio is 1.67, or 25 divided by 15. So ultimately, the answer to the question “what is a good PE ratio for a stock? ” is that – like all financial ratios, the P/E ratio is just one indicator that needs to be used in context with other data points and fundamental research in order to make an intelligent investment decision. This is the same if we ask “what is a good ROE“, or “what is a good P/B”, or what is the best entry point of the trade. It’s best used as a relative metric i.e. when comparing P/E ratios between similar companies operating within the same industry.
In the example above, we can see that Mcdonald’s is poor value relative to the U.S. market from a P/E perspective, but good value relative to the US Restaurant industry. Despite strong returns over the past several years, the utilities sector has lagged through 2021, rising just 14% compared to 43% for communications and 30% for industrials. Sign up for our daily newsletter for the latest financial news and trending topics. You want to be a successful stock investor but don’t know where to start.
The PE ratio can tell you what kind of premium investors are willing to pay to get a piece of this company. PE ratios should always be considered in the context of the industry group. The information on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. Accepts no responsibility for any use that may be made of these comments and for any consequences that result. Or, to look at it another way, if the stock price and earnings stay constant, it would take 30 years for the company to have enough profit to recoup the share price.
Referred to by the acronym BEER (bond equity earnings yield ratio), this ratio shows the relationship between bond yields and earnings yields. Some studies suggest that it is a reliable indicator of stock price movements over the short-term. The price-to-earnings ratio, or P/E ratio, helps you compare the price of a company’s stock to the earnings the company generates. This comparison helps you understand whether markets are overvaluing or undervaluing a stock.
- This can be useful given that a company’s stock price, in and of itself, tells you nothing about the company’s overall valuation.
- For this example, we’ll use the closing stock price on March 17, 2023 and the annual EPS as of December 31, 2022.
- Warren Buffett has been the most well known and successful investor who used the concepts of value investing and buying with a margin of safety to earn superb returns over many decades.
- If earnings are negative, the P/E ratio can be calculated, but a negative P/E ratio is generally not useful for comparison purposes.
Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 69% of retail investor accounts lose money when trading spread bets and CFDs with this provider. You should consider whether you understand how spread bets and CFDs work, and whether you can afford to take the high risk of losing your money. Calculated by dividing the current stock price by earnings per share, the P/E is one of the simplest, most straightforward tools for reflecting the market’s consensus of a company’s growth prospects. A P/E ratio, or Price-to-Earnings ratio, is a financial metric used by investors to determine the market value of a stock compared to its earnings.
On the other hand, the reverse has held during other periods, which then supports Ben Graham’s investment process. Even before the dotcom madness of the 1990s, some believed that comparing a stock’s price to its earnings was shortsighted at best and pointless at worst. When a company has a high P/E ratio, it might be considered overvalued, especially if that P/E ratio is high compared to similar companies or a market benchmark. On the other hand, if a company has a low P/E ratio, it could be a sign that a company is undervalued.
In fact, it’s one of the most widely used ratios when analyzing a stock’s value. Based on the historical average, the S&P 500 is slightly overvalued today. That is, the economic and earnings outlook for the S&P 500 is expected to be below historical norms. Understanding “what is a good PE ratio for a stock” starts with comparing the P/E ratio to a benchmark. The P/E ratio is meant to display how “expensive” a stock is relative to its peers (industry) or itself (historically).
When you buy a stock with a lower P/E ratio, expectations around future growth tend to be lower, and so it’s easier for a company not to disappoint those expectations and cause big stock sell-offs. The average P/E of the stock market has traded lower than the mark in bear markets with economic recessions, or time periods with higher interest rates or general uncertainty. The short answer is that it depends—it depends where the market is, what a company’s future growth rate is expected to be, and the uncertainty of that growth.
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This is especially true with sell-side analysts, who often change their estimates frequently as a stock performs better or worse than expected. Their price targets are often way off the mark, and often overly optimistic, yet they are not generally held accountable for these errors. Over history, the average P/E ratio of the stock market has been around 15-17. How Wall Street expects a company to grow tends to set its P/E ratio more than anything else, as the P/E is a good shortcut to understanding how bullish or bearish investors are on the stock.
What is the PE Ratio?
That’s a reason not to compare, say, a manufacturing company and a tech company based solely on P/E ratio. You probably won’t have to calculate each company’s P/E ratio yourself, but in case you’re curious, the P/E ratio is price-per-share/earnings-per-share. It could lead a value investor to think that the company’s stock might be undervalued and therefore a bargain worth snapping up. A company’s P/E ratio is calculated by dividing the stock price with earnings per share (EPS). The question of what is a good or bad price-to-earnings ratio will necessarily depend on the industry in which the company is operating. Some industries will have higher average price-to-earnings ratios, while others will have lower ratios.
Differentiating between overvalued stocks and growth stocks comes down to further analysis. Or is there a better reason investors are anticipating higher future returns? These are questions you could ask to decide if it might be time to buy, sell or hold. The higher the P/E ratio, https://bigbostrade.com/ the more you are paying for each dollar of earnings. This makes a high PE ratio bad for investors, strictly from a price to earnings perspective. A higher PE suggests high expectations for future growth, perhaps because the company is small or is an a rapidly expanding market.
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Ratios below 10 can indicate a possible bargain, while a ratio above 20 may indicate that the stock is expensive. Additionally, different industries can have wildly different P/E ratios (high-tech industries and startups often have negative or 0 P/E while a retailer like accurate currency strength meter Walmart may have 20 or more). The stock market fluctuates constantly, and so the price of a stock yesterday is not always a good indication of the price tomorrow. Cautious investors don’t always trust the calculations of analysts or the figures published by a company.
If you have previous work or internship experience related to investing or investment management, it is likely understood that you can use and calculate P/E ratios. They are also a core factor to consider when investing in the stock market. Ultimately, any work or internship experience that involves investing will inherently include an understanding of P/E ratios. Because Company B is cheaper per share, it is tempting to assume it is a better deal than Company A. However, Company A is cheaper because you are paying less for every $1 of earnings per year. Especially if we take into consideration that the industry average for these companies is 30x, Company A is the more “on par” investment — it is well-priced compared to most companies in the industry.
The third type is the absolute P/E ratio, which uses current stock price and data from both the past 12 months and future projections. Value investors tend to look for stocks that are trading at lower valuation multiples, with a low P/E ratio being one example of that, and tend to “buy low” and “sell high” in order to earn higher returns. A stock cannot sustain high share prices for very long without also growing its earnings per share (EPS) to a high rate. Though investors can use metrics like the P/E ratio to examine a company’s past, investment results and future compounding depend on a company’s future. But the average P/E of the stock market has fluctuated for many reasons over time, and actually has rarely traded right at that average mark. For example, in bull markets where investors tended to be more optimistic, average P/E’s traded much higher than 15-17.