July 27, 2011 | In: General

What Is a Good P/E Ratio?

A P/E Ratio (meaning the Stock Price/Earnings ratio) is an important metric in assessing the health of a stock. A P/E Ratio is simply the price of the stock divided by the current yearly earnings per share. Let’s look at C (NYSE:C). C has a current price of $39.72 and its current yearly earnings (also known as EPS or Earnings Per Share) are $3.29. This means that C’s P/E ratio is $39.72 / $3.29 = 12.07. In other words, it will take Citigroup 12 years to buy back all its stock provided it can sustain the current EPS. Generally, the lower the P/E ratio is, the more of a bargain the stock is. However, this is not always the case….

I have discussed before the dangers of a low P/E ratio; in short, a very low P/E means that the investors do not trust neither the company nor its stock. This is generally due to a gloomy future that the investors believe that the company will face.

On the other hand, a very high P/E ratio means that the investors have high hopes and expectations about the stock, and the company persistently beats their expectations. Examples of stocks trading at a very high P/E ratio are: NFLX (P/E ratio is 76), AMZN (P/E ratio is 93), and LNKD (P/E ratio is 2825, which makes it one of the most overvalued stocks of all time).

So, we know now that both very high and very low P/E ratios are not signs of healthy stocks. So what is a good P/E ratio?

I think a P/E ratio between 10 and 30 is a good P/E ratio, it’s not that high, it’s not that low. Anything falling between 15 and 20 is ideal. Keep in mind, however, that a good P/E ratio alone is not the one and only sign of a good stock, there are many other factors that should be taken into consideration before deciding on buying a stock…

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