Often, we hear about undervalued stocks that can pay you good profit returns on your investment. It is advised to choose undervalued stocks avoiding the overpriced one. So how can you decide which dividend paying stock is overpriced and which is running undervalued in UK? Obviously by checking it’s P/E ratio and earnings per share. To identify a particular stock you should know about P/E ratio and should be able to evaluate a dividend stocks on it’s P/E whether this is having good P/E or bad.
In this post I am going to tell you that what is P/E ratio all about? What it means and what it says about a particular stock.
P/E ratio is a short abbreviation given to price to earnings ratio and it is calculated as market value per share (stock price)divided by earning per share (EPS). For example suppose stock price for an organization is $50 per stock and earnings for organization in last 12 months were $2 per stock then it’s P/E would be $50/$2=25.
Here, earnings per share are taken from last 4 quarters(12 months) hence P/E calculated will be known as trailing P/E. Usually earnings per share are taken from past 12 months or 4 quarters but sometimes it is taken from earnings expected from next 4 quarters or in 12 months. P/E generated using next 4 quarters earnings per share is known as forward P/E or projected P/E. Besides of these two calculation methods, there is a third theory also in which EPS taken for calculation is the sum of eps taken from past 2 quarters and estimates of next 2 quarters.
Now lets take a look at what a high P/E means and what a low P/E means in all aspects. If a company A is having high P/E rating than company B then it generally means that investors of company A are expecting a high growth in earnings compared to investors of the company B. P/E ratio are specially useful while comparing P/E ratio for two companies that are in same industry, but remember it does not tell the whole scenario. P/E ratio comes handy when you want to compare two companies which are operating in same industry. Some people misunderstood it and use p/e as a base while comparing p/e of two companies operating in different industries.