Here are some pointers about P/Es.
If you take a large group of companies, add their stock prices together, and divide by their earnings, you get an average P/E ratio.
On Wall Street, they do this with the Dow Jones Industrials, S&P 500 stocks and other such indexes. The result is known as the "market multiple" or "what the market is selling for."
- The market multiple is a useful thing to be aware of, because it tells you how much investors are willing to pay for earnings at any given time.
- The market multiple goes up and down, but it tends to stay within the boundaries of 10 and 20.
- The stock market in mid-1995 had an average P.E ratio of about 16, which meant that stocks in general weren't cheap, but they weren't outrageously expensive, either.
In general, the faster a company can grow its earnings, the more investors will pay for those earnings.
- That's why aggressive young companies have P/.E ratios of 20 or higher. People are expecting great things from these companies and are willing to pay a higher price to own the shares.
- Older, established companies have P/E ratios in the mid to low teens. Their stocks are cheaper relative to earnings, because established companies are expected to plod along and not do anything spectacular.
Some companies steadily increase their earnigns - they are the growth companies.
Others are erratic earners, the rags-to-riches types. They are the cyclicals -
- the autos, the steels, the heavy industries that do well only in certain economic climates.
- Their P/E ratios are lower than the P/.Es of steady growers, because their perfomance is erratic.
- What they will earn from one year to the next depends on the condition of the economy, which is a hard thing to predict.