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What is a P/E Ratioand Why Should I Care?

Allen HoldsworthIllowa Buy States Chapter

BIVA Board Director

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Disclaimer• The information in this presentation is for educational purposes only and is not

intended to be a recommendation to purchase or sell any of the stocks, mutual funds, or other securities that may be referenced. The securities of companies referenced or featured in the seminar materials are for illustrative purposes only and are not to be considered endorsed or recommended for purchase or sale by BetterInvesting™ National Association of Investors Corporation (“BI”) or the BetterInvesting Volunteer Advisory Board, its volunteer advisory board (“BIVAB”). The views expressed are those of the instructors, commentators, guests and participants, as the case may be, and do not necessarily represent those of BetterInvesting™ or BIVAB. Investors should conduct their own review and analysis of any company of interest before making an investment decision.

• Securities discussed may be held by the instructors in their own personal portfolios or in those of their clients. BI presenters and volunteers are held to a strict code of conduct that precludes benefiting financially from educational presentations or public activities via any BetterInvesting programs, events and/or educational sessions in which they participate. Any violation is strictly prohibited and should be reported to the President of BetterInvesting or the Manager of Volunteer Relations.

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Understanding P/E Ratios

• Presented by:• Allen Holdsworth• Illowa Buy States Chapter-

Director• BIVA Board-Director• Teach 16 week Personal

Investing class at community college

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What is a P/E Ratio?

• It is NOT gym class• No need to get all sweaty• You can figure out P/E ratios

even if you can’t walk and chew gum at the same time!

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What is the P/E Ratio?

• The P/E ratio is the price per share of stock divided by the earnings per share of stock

• The question is - which earnings are used?

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Understanding P/E Ratios

• P/E Ratio means:• Price per share divided by the

earnings per share from the last 4 quarters

• This is the trailing P/E• Price changes every day• Earnings per share only changes

each quarter

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Understanding P/E Ratios

• Value Line uses current P/E--Use the last 2 quarters plus the next 2 quarters in the future

• Future P/E uses the projected earnings over some future time period

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P/E Ratios

• The P/E ratio is the amount of money someone is willing to pay to get $1 of earnings

• It could be considered a popularity contest

• In general - the faster a company is growing, the higher the P/E it will have

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P/E Ratios

• What makes the P/E change?• The future growth prospects are

the driving force in price and P/E

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P/E Ratios

• What is a good P/E or a bad P/E• Is a P/E of 20 good or bad?• It depends!!!!

– Look at past history of P/E ratios– Look at other companies in same

industry– Look at average P/E for S&P 500– Look at the prospects for the company

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P/E Ratios

• In general, the faster a company grows - the higher the P/E ratio

• As the growth of a company slows over time - the P/E ratios will usually come down

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P/E Ratios

• Different types of industries tend to have different P/Es - even if the growth rates are similar

• Part 3 of the Stock Selection Guide helps us determine the normal range of high and low P/E

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P/E Ratios- Pulte Homes

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P/E Ratios-BUD

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P/E Ratios- BBBY

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Section 3- Apple Computer

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XM-How do you make an estimate?

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P/E Ratios in Section 3

• Eliminate outliers - can see the last 10 years of P/Es on Toolkit- click on avg. high or avg. low P/E box in Section 3

• P/E expanding - use average• P/E shrinking - use most recent or

even lower• Max. high P/E of 30 (1.5 times growth

rate or sometimes 2 times growth rate)

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P/E Ratios

• Don’t buy a stock just because the P/E ratio is low

• Do more research - try to discover why it is low

• There may be bad news and it deserves to be low

• The future growth prospects are the real driving force

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P/E Ratios

• There are 7 basic ways a company can increase earnings– Reduce costs– Raise prices– Open more stores/expand– Sell more in existing markets– Fix or sell losing operations– Buy back shares– Lower taxes paid

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Understanding P/E Ratios

• References: from BetterInvesting:– Stock Selection Handbook– Using Portfolio Management

Wisdom

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