Ok let’s dive into the PE Ratio, an important measure of value!
This ratio along with dividend yield will help make sure you don’t pay too much for a dividend stock. It tells you how many times earnings you would be paying at the current market price for a given company.
Buying dividend paying companies while they value priced is very important to long term returns! Don’t worry, you'll learn more about value later on.
First you’ll learn what the key financial ratios are, then how to use them.
To calculate the Price to Earnings Ratio:
PRICE TO EARNINGS RATIO = CURRENT SHARE PRICE/*EARNINGS PER SHARE (EPS)
*If EPS represents past earnings, you will get a Trailing Price to Earnings Ratio. If EPS is projected, it will be a forward Price to Earnings Ratio.
Ok here comes an example...
XYZ Financial (a company we know well!) posted annual earnings of $40 Billion dollars last year ($5.00 in per share earnings). The current share price is $48.50.
So using the above equation... $48.50/$5.00 = 9.7
So the market is currently valuing XYZ at 9.7 times last year’s earnings. Sounds like a great buying opportunity if the company is in good shape.
Price to Earnings Ratios reflect the market’s opinion about a stock. If the ratio is low, it usually means the market is pessimistic about the stock for one reason or another. The opposite is also true. This pessimism is often overstated causing stocks to be undervalued.
When the economy is down, the ratio of the overall market is often low because fear causes people to sell off their positions. This leads to lower prices and great buying opportunities!
The key to maximizing long term returns is buying high quality dividend paying stocks when they are value priced and the Price to Earnings Ratio is one measure that helps you to determine value. We will run through our criteria for spotting value later on.
Congrats you passed the lesson on the Price to Earnings Ratio. There is still lots to learn so let’s keep moving!
Return from PE Ratio to Evaluating a Dividend Paying Stock
Return from PE Ratio to Dividend Freedom Home Page