Wednesday, September 10, 2008

Understanding The P/E Ratio

Many analyst and investors use the P/E or Price Earnings Ratio in the valuation of stock investments. Believe it or not, there are at least seven different forms of the P/E. P/E is certainly an important measure to review, but I do believe cash flow measures are equally important, if not more important. I have written several earlier posts on why cash flow and its the various ratios can be more useful. One such post titled, The Importance of Understanding the Difference between Earnings, Operating Cash Flow and EBITDA, will provide some detail behind the differences between cash flow and earnings type data. However, since the P/E ratio receives a lot of attention, having a greater understanding of this ratio could enhance ones analysis skills.

A recent article by the American Association of Individual Investors, Will the Real P/E Please Stand Up?, describes the different P/E calculations. Additionally, the article provides information on how these different P/E ratios are interpreted. Before reading the article at the link at the bottom of this post, reviewing the definitions of the various forms of P/E might be benefical.

(click on table for larger image)

different forms of the price earnings ratio or P/EI can't think of one single variable that can be used successfully in determining whether a stock is a good investment or not. Therefore, one should incorporate these P/E variations with other fundamental data before making purchase and sell decisions.


Will the Real P/E Stand Up?
American Association of Individual Investors
AAII Journal

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