Stock price earning ratio

Price earning ratio is a very useful information on any particular stock.

This ratio gives you a relation to the price of the stock compared to the profit that the company makes.

A good average for this ratio is about 15.

That means that the stock sells for 15 times its earnings or profit. If the market expect a company to make lot's of profit, the price will go up and the price earning ratio also.

Should you buy a stock when the price-earning ratio is very high?

When the ratio is high, the price of the stock has more chances to go down than up. There are exceptions, but be very careful with too high price earning ratio.

If you buy this type of stock, make sure you know very well the sector that the company is in; compare with other stocks in the same sector.

Check management, check the business plan, if the company has a growth rate superior to the sector, this may justify a higher price-earning ratio.

Good example.

Some P/E ratio are way high, take Google for example its P/E is approaching 90, we would not buy it at such a high value, even if that company makes almost 25% profit on its sales. Yahoo that is in the same sector has a price earning ratio of around 25 that is more reasonable and they make over 30% profit on sales.

The growth rate of Google is phenomenal, but will it keep growing at that rate, sales doubled from 2004 to 2005. This is a very difficult pace to maintain. We think that at some point, their growth rate will level off.

What will append to the price of their stock then? It will go down and with it, their P/E. Will the profit maintain? Their profit in 2005 was 3.65 time that of 2004.

Yahoo on the other hand had a growth rate of about 65% from 2004 to 2005. Their profit in 2005 was 2.25 times that of 2004.

That is a good example of very different P/E for companies in the same sector.

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