P/E Ratios

PE ratios, another one of those financial jargon terms that you may hear when you’re watching the News or your Advisor has mentioned it before. Our job here at Retiring Well is to make sure and try to educate you on what all this means. So PE ratios or the price to earnings ratio is a ratio for valuing a company that measures its current share price relative to its earnings per share. So the share of market price tells you how much people are willing to pay. But essentially the PE ratio is going to tell you if the price accurately reflects their earnings potential or their value. So let’s take for example a stock that’s $100 per share and it generates $4 per share in annual earings. So the PE ratio of this is 25. So it’s essentially saying it takes 25 years of accumulated earnings to equal the cost of the investment. Now keep in mind the higher the ratio, essentially the more expensive a stock is relative to its earnings. The lower the ratio the less expensive. So stocks and equity mutual funds can be classified as a growth stock when they’re above the average ratio. So also think back historically when you look at say an index like the S&P 500. The historic average PE ratio for a number of these stocks is around 16, 17 is sort of their PE ratio. So let’s take for example though as the day of this filming, Amazon’s PE ratio is in the mid-60s. So they’re definitely considered then a growth company. Meanwhile you look at lower PE ratios, they’re going to tend to be more of your value types of companies. So I looked and again at that time of this filming Bank of America has a PE ratio around 13. So again, more of say a value type of stock. So the PE ratio isn’t going to help you necessarily predict what those short-term movements are going to look like. As we all know with stocks, they go up, they go down type of thing. But the PE ratio helps you sort of measure the company’s value. So again, if you’re getting into different individual stock trading and all that, it’s very important that you again look to diversify your portfolio and not solely rely on one stock as we all heard the good and the bad of that type of investing and how some stocks can really take off and do well, but just as quickly they can drop. So again, it’s one of those where if you’re evaluating your retirement plan and would like assistance, we’d love that opportunity for a no cost, no obligation second opinion.