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Is Stock Trading on High Price Earnings (P/e) Ratio a Good Stock or Not?

By Idika Agwu Aja

Summary

Price earnings ratio is widely and commonly used in determining if a stock is over or undervalued. Basically, price earnings ratio, expresses the relationship between current stock market price per share and the reported yearly earnings per share; usually of the last quarters. It derived its meaning from the payback multiple, which is the time it will take to recover one’s investment. It also, shows what the market or investors are willing to pay today for a stock based on its past and future earnings. Hence, it helps investors determine the price of stock compared to the earnings of the company.
Is Stock Trading on High Price Earnings (P/e) Ratio a Good Stock or Not?
 
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Published: October 23, 2019

Uploaded by: Idika Agwu Aja

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Abstract

PE and PEG ratios and earning yield are metrics used to wconfirm if a stock is cheap or not holding constant other variables as well as their inherent pitfalls.

PE shows what the market or investors are willing to pay today for a stock based on its past and future earnings.  It helps investors determine the price of stock compared to the earnings of the company.

Earning yield, which is the inverse of Price Earning shows the percentage of each Naira invested in the stock that was earned by a company. The earning yield is usually used to determine the optimal asset allocations. This is done by comparing it to a broad base interest rate such as Treasury bonds, index, such NSE, etc. If the earning yield is less than the rate, for example a 10-YR bond yield, the stock may be considered overvalued. If the earning yield is higher, the stock may be considered undervalued relative to the bench mark (Bond or Index.).

Equally too, price earnings growth ratio (PEG), which is an improvement of PE ratio can be used to determine if stock is over or undervalued.  It shows the relationship between PE ratio and a company’s earnings growth rate. PEG ratio just like PE ratio assumes that share price represents stretch of future earnings.  The assumption is that, If PEG = 1, the stock is fairly prices; <1, it is undervalued (buy) and >1, sell and >2 strong sell, which means you are paying much based on the EPS growth at the current/buying stock price.

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Idika Agwu Aja

Idika Agwu Aja

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