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I have received a few comments asking about what I believed to be the most important ratios in valuing a stock. So, today I want to take time and look at a few financial terms that are important to know when investing. Over the next few weeks, I will highlight important terms that investors should know about. This will benefit beginning investors and intermediate investors alike.
Investing For Beginners
1. P/E Ratio
The P/E ratio is probably the most important metric to use in valuing a stock. P/E stands for price to earnings. This is known as the earnings multiple. It represents how much an investor is willing to pay for a company’s earnings. For example, if a company has a PE of 20, that means that investors are paying $20 for every $1 of earnings.
2. PEG Ratio
Sometimes the P/E ratio isn’t enough when valuing a stock. The P/E ratio is a useful stat but it can be misleading when judging a company with great growth rates. The PEG ratio is a better measurement because it helps you determine just how you are paying for a company’s earnings growth. For example, a company with a P/E ratio of 40 may seem expensive but it isn’t if the company is growing earnings at a 40% clip. That would be right inline with the P/E.
3. P/B Ratio
The price to book value ratio measures a company’s stock price by its book value. An undervalued stock can often be identified by a lower price to book ratio. An overvalued stock can often be found in stocks with a higher price to book ratio.
Of course none of these matter if you are speculating and not investing!
True Moneycone. Speculating is a whole lot easier!
Surprised you don’t talk about how to estimate the intrinsic value of a company since Buffett constantly talk about that in his annual reports and in much that he has written.
Balance sheet and cash flow ratios should also be considered, as well as benchmark comparisons to industry ratios. These can be found on Yahoo finance industries page, or on most sites if you enter the corresponding ETF ticker for that industry.
Don’t forget dividends… Looking at Berkshire Hathaway’s current holdings, you wont see too many companies that don’t pay a constantly increasing dividend.
Pat
I like how the explanations are simple and to the point. In studying investing , I have learned that sometimes, things are explained in a way that are more difficult than they really need to be. Glad to have come across this site, I will be back in the future. best, David