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How to Analyze Company's Price to Earnings Ratio?
Any investor knows that an earnings analysis is crucial before taking the step of investing money in a company or stock. This is done using the price to earnings ratio. A company files an earning report every quarter, or four times a year. These reports are normally filed in January, April, July, and again in October of each year. An earnings report contains all the information needed by investors to determine the performance of the company. Earnings reports include net sales, net income, earnings from continued operations, and earnings per share for the last quarter. The quarterly earnings report can help an investor do an earnings analysis and determine the strength and health of the company financially.
The price to earnings ratio is one of the most commonly used equations when it comes to an earnings analysis. This equation can help determine the relationship that exists between the earnings of a company and the price of the stock. But how is the price to earnings ratio calculated? The equation to get to this ratio number is very simple. The share price of the stock is divided by the earnings per share for the company. The earnings per share for a company must be calculated before the price to earnings ratio can be determined. To calculate the earnings per share for a company, another equation must be used. The dividends on preferred stock is subtracted from the net income of the company, and the answer is then divided by the number of average outstanding shares the company has. The number of outstanding shares will vary, and using the number of outstanding shares at the end of the quarter is one method used. The other method is to use a weighted average number of outstanding shares.
The price to earnings ratio is crucial for a correct earnings analysis. This number can tell you a lot about the stock you are considering. The price to earnings ratio will help you determine what the market will pay for the earnings from the company. If the ratio number is high, the market may be willing to cough up a substantial amount for the stock. Care should be used though, because a stock with a high ratio number may be over valued. This is not always true though, and the high ratio number could also mean high hopes in the market for the company. A low price to earnings ratio may also be seen as either a good or bad thing when doing an earnings analysis. Some traders may feel that there is no confidence in the company, and this can be a sign of rough times. Others may consider these stocks as under valued, and may consider them value stocks to grab while the timing is right. Some value stocks have gone on to become blue chip stocks, so a low ratio number can be seen either way, depending on the trader.
The price to earnings ratio is one way to do an earnings analysis. This number is easy to calculate, after the earnings per share has been figured. Many traders use the price to earnings ratio, along with the earnings reports and other information, to determine whether to invest in a stock and company or not. A thorough and complete earnings analysis is crucial when deciding on whether an investment is for you or not. There is no magic ratio, and only you as the investor can determine what ratio number is too high or low, and whether a stock is a diamond in the rough or an overpriced balloon waiting to pop.
The information supplied in this article is not to be considered as medical advice and is for educational purposes only.