Technical analysis 101: PE ratio, Pros /Cons and Cases
Continuing on sharing on basics of analysis, Follow me @Alice Arnault and let us learn more together
Previously i have commented on @nerdbull1669 and @KYHBKO Article and some have asked me to share more on this topic
Price to Earnings ratio is calculated as follows:
P/E Ratio = Stock Price / Forward Earnings Per Share (EPS)
The P/E ratio is widely used for several reasons:
Strengths:
a. Ease of calculation: The P/E ratio only requires two readily available data points - stock price and earnings per share.
b. Simplicity: The metric is easy to interpret, as it represents the price an investor is willing to pay for each dollar of a company's earnings.
Weaknesses:
a. Manipulation of EPS: Earnings per share can be manipulated through various accounting practices or non-recurring items, affecting the reliability of the P/E ratio.
b. Non-cash items: The P/E ratio does not account for non-cash items like depreciation and amortization, which can significantly impact a company's financial performance.
Let's explore these aspects further with some real-life examples and quantitative analysis.
Case 1: Apple Inc. (AAPL)
As of September 2021, Apple had a P/E ratio of around 28. Considering the historical average P/E ratio for the S&P 500 is approximately 15-17x, Apple's P/E ratio might seem high. However, we must consider Apple's growth potential and strong financials, which have led investors to be willing to pay a premium for the company's shares.
Case 2: General Electric (GE)
In contrast, General Electric had a P/E ratio of around 23 in September 2021. Although this P/E ratio is lower than Apple's, it may not necessarily indicate a better investment opportunity. GE's financial performance has been lackluster in recent years, and the company has faced numerous headwinds. In this case, the P/E ratio could be misleading due to GE's lower growth prospects and financial stability.
Quantitative Analysis:
To further illustrate the importance of context when using the P/E ratio, let's examine the P/E ratios of different sectors. As of September 2021, the Information Technology sector had an average P/E ratio of 36.07, while the Energy sector had an average P/E ratio of 18.46.
This indicates that P/E ratios can vary significantly across industries, and comparing companies within the same sector can provide more insightful information.
Disclaimer: Investing carries risk. This is not financial advice. The above content should not be regarded as an offer, recommendation, or solicitation on acquiring or disposing of any financial products, any associated discussions, comments, or posts by author or other users should not be considered as such either. It is solely for general information purpose only, which does not consider your own investment objectives, financial situations or needs. TTM assumes no responsibility or warranty for the accuracy and completeness of the information, investors should do their own research and may seek professional advice before investing.
I use technical for entry to try to remove the emotions after fundamental analysis.
PE is a good starting point and comparing with industry average is a good recommendation.