P/E Relative Screen
|P/E Relative||S&P 500|
|Five Year Return:||5.5%||8.7%|
|Ten Year Return:||9.6%||4.7%|
The price-earnings ratio, or earnings multiple, is one of the most popular measures of company value. It is computed by dividing the current stock price by earnings per share for the most recent 12 months. It is followed so closely because it relates the market's expectation of future company performance, embedded in the price component of the equation, to the company's actual recent earnings performance. The greater the expectation, the higher the multiple of current earnings investors are willing to pay for the promise of future earnings.
If the market has low earnings growth expectations for a firm, or views earnings as suspect, it will not be willing to pay as much per share as it would for a firm with high and more certain earnings growth expectations.
That does not mean that all stocks with low price-earnings ratios have little or no growth prospects. While most firms deserve their low ratios, value investors seek companies with low price-earnings ratios in the belief that through neglect or overreaction to bad news, the market has not correctly evaluated the earnings potential of the company. Value investors argue that although the market may be efficient in the long term, emotions often dominate in the short run. These emotions can overtake rational analysis, pushing a stock's price above its intrinsic value during periods of euphoria and below its true worth when reacting to bad news.
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