It is a worthwhile exercise to consider the actual significance of comparing price to earnings and to review its calculation. P/E is found by dividing the current price per share by the latest known earnings per share (EPS).
The price is the current price of the stock; and since price may change frequently, P/E is an everchanging ratio as well. Earnings is more elusive because the number is published only periodically, so when you use the P/E you are comparing today's stock price to earnings that may be far out of date, perhaps by as much as three months. With this in mind, giving value to the P/E should be done cautiously; it may be more revealing to study the P/E trend. Compare price as of the closing date of a quarterly financial statement to earnings as of the same date, and use the trend as a means for judging the stock's value.
EPS is not an exact value. Because the latest published earnings may reflect a specific seasonal high or low point for the company, using outdated earnings in the P/E calculation can be quite inaccurate. A retail concern's fourth quarter may reflect exceptionally high earnings due to high volume in the holiday season. By February, however, volume will be considerably lower. Thus, comparing a February price to December 31 earnings is anything but reliable.
Was this article helpful?
In This Book, you will learn all about the fundamentals of true financial empowerment! Gone are the days of thinking like a poor person's mindset. It is time to change that way of thinking so that you will truly attract wealth in your hands.