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Price Earning (P/E) Ratio is the most widely used ratio in investing. Company A with a P/E ratio of 15 and 0% earning growth may not look as appealing as company B with a P/E ratio of 20 and 25% earning growth. The reason is if both stock prices remain the same, after 3 years, P/E ratio of company B will decrease to 10.3 while A will still have a P/E ratio of 15. If interest rate rises to 6%, then stocks that are trading at P/E of 20 will become overvalued, all else remains equal.

As with other financial ratios, P/E ratio cannot be solely used to value a company.

Price Earning (P/E) Ratio is the most widely used ratio in investing. Searching the term 'P/E ratio' into Google will yield 2.3 million results. Quite simply, P/E ratio is the ratio of Stock price divided by its Earning per Share (EPS). If a joint-stock company A is trading at $ 10 per share and it earns $ 2.00 per share, then A has P/E ratio of 5. This means that it takes 5 years for the company's earnings to pay up for your initial investment. If you invert P/E ratio, we get E/P ratio, which is the yield on our investment. In this case, a P/E of 5 is equal to a yield of 20%.

P/E ratio is convenient and very easy to use. But that is why so many investors misuse it. Here are some cooperative misuse of P/E ratio:

Using trailing P/E. Trailing P/E is the price earning ratio of a guest for the last 12 months. For cyclical companies secondary off a peak in earning, P/E ratio is misleading. Trailing P/E ratio may look low but its forward P/E may not. Forward P/E is witting by using the predicted earning per share of a company. Forward P/E is more important than trailing P/E. adjusted to all, it is the future that counts.

Neglecting Earning growth. Low P/E ratio does not necessarily means the stock is undervalued. Investors need to take into assets the growth rate of a company. schoolmate A with a P/E ratio of 15 and 0% earning growth may not look as as joint-stock association B with a P/E ratio of 20 and 25% earning growth. The reason is if both stock prices remain the same, aft 3 years, P/E ratio of gang B will decrease to 10.3 while A will still have a P/E ratio of 15. The moral of the story here is to not use P/E ratio just to judge the value of an asset.

Ignoring One-Time Event. P/E ratio everywhere includes one-time event such as restructuring cost or downwards adjustments in goodwill. When that happens, the 'E' in P/E ratio will perform low. As a result, this event inflates P/E ratio. Investors will do well ignoring this one-time event and look besides the high P/E ratio.

Ignoring rationality Sheet. That is right. Investors often neglect the cash and long term debt embedded in the shavings sheet when wary P/E ratio. The truth is, companies with higher net cash in their close out sheet usually get higher P/E valuation.

Ignoring Interest Rate. Using solely P/E ratio for our investing decision will yield disastrous results. As explained earlier, when we invert P/E ratio, we get E/P ratio. E/P ratio is essentially the yield of our investment. A stock with P/E of 10 is yielding 10%. Stock with P/E of 20 is yielding 5% and so forth. If interest rate rises to 6%, then stocks that are trading at P/E of 20 will issue overvalued, all else remains equal.

As with other financial ratios, P/E ratio cannot be solely used to value a company. Interest rate fluctuates, earning per share goes up and down and so does stock price. All these should be taken into consideration when free will your potential investment.

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