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| My Stock Consultants |
BEWARE THE "P/E TRAP"
This ratio is simply the market price of a company's shares divided by the company's earnings per share. It is widely and incorrectly viewed as a measure of value - apparently a rapid way to determine if a company's shares are cheap.
Many use it because it is easy to calculate. But for investment success the path of least resistance is not reliable.
Take for example 2 companies, each with $10 of equity, producing a return on equity of 5%, and each trading on a P/E ratio of 10, would produce entirely different returns to the investor if there was any variation in the dividend payout ratios. For this reason the P/E ratio of 10 has told the investor nothing about which company is better value.
Simply put ~ Price is what you pay, but Value is what you get. Because the P/E ratio uses price it cannot estimate value.
Companies with...
# Proven ability to re-invest profits consistently at a high level of ROE
# Conservative interest-bearing debt
# Low investment in operating capital assets
...would be the kind of stocks to look for.
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; "My Stock Consultants")
