What is a price-earnings (P/E) ratio and is it important?
A price-earnings (P/E) ratio measures the value of a stock by dividing the current price by its earnings per share over the last 12 months. When a stock’s P-E ratio is high, the majority of investors consider it as pricey or overvalued. Stocks with low P-E’s are typically considered a good value. However, through Investor’s Business Daily’s ongoing study of the biggest stock market winners, the opposite was found to be true. The average P/E of the best winners over the last 15 years at the initial buy point prior to their huge price increases was 31 times earnings. These P/E’s went on to expand more than 100% to over 70 times earnings as the stocks significantly increased in price. If you picked stocks based solely on low P/E’s, you would have missed purchasing America Online and Cisco Systems during the period of their greatest market performance.
