Development of the PE

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published only periodically, so when you use the P/E you are comparing today's stock price to earnings that may be far out of date, perhaps by as much as three months.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 Because the latest published earnings may reflect a specific seasonal high or low point for the company, using outdated earnings in the P/E calculation can be quite inaccurate.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.

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