Question

Describe at least three indicators that you would use to determine whether the stocks are inexpensive.    How would use these indicators?

Answer 1

1. Earnings per share (EPS) : This is the amount each share would get if a company paid out all of its profit to its shareholders. EPS is calculated by dividing the company’s total profit by the number of shares.

Example – If a company’s profit is $200 million and there are 10 million shares, the EPS is $20.

EPS can tell you how companies in the same industry compare. Companies that show steady, consistent earnings growth, year after year, will often outperform companies with volatile earnings over time.

2. Price to earnings (P/E) ratio : This measures the relationship between the earnings of a company and its stock price. It’s calculated by dividing the current price per share of a company’s stock by the company’s earnings per share.

Example – A company’s stock currently sells for $50 per share and its earnings per share are $5. That means it has a P/E ratio of 10 ($50 divided by $5).

The P/E ratio can tell you whether a stock’s price is high, or low, compared to its earnings.

Some investors consider a company with a high P/E to be overpriced. But sometimes a company with a high P/E today may offer higher returns, and a better P/E, in the future. How do you know? You’ll likely have to look at other indicators before you decide.

3. Price to earnings ratio to growth ratio (PEG): This helps you understand the P/E ratio a little better. It’s calculated by dividing the P/E ratio by the company’s projected growth in earnings.

Example – A stock with a P/E of 30 and projected earnings growth next year of 15% would have a PEG of 2 (30 divided by 15). A stock with a P/E of 30 but projected earnings growth of 30% will have PEG of 1 (30 divided by 30).

The PEG can tell you whether a stock may or may not be a good value. The lower the number, the less you have to pay to get in on the company’s expected future earnings growth.