When Is Formula Going To Be Back In Stock How to Make Money From the Stock Market

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How to Make Money From the Stock Market

One of the most commonly used metrics is the price-to-earnings ratio, or P/E. You can find the P/E on many financial websites that cover individual companies. P/E refers to the price per share to earnings (also known as net income) per share.

Any company with a P/E of less than 10 is worth checking out. But P/E is not the be-all and end-all of judging a company’s value. First, you need to be sure what P/E means. Typically, value refers to the current price and earnings refers to the company’s earnings over the past 12 months. Sometimes this will be called the “trailing” P/E.

The problem with the trailing P/E is that it is backward looking. It’s also worth looking at the company’s future (or forward) P/E or its value compared to projected earnings for the next 12 months. If earnings (the denominator) are increasing, the P/E ratio will be decreasing compared to the trailing P/E.

That’s what you like to see.

Another way to look at a company’s future prospects is by looking at its PEG or price-to-earnings-to-growth ratio. Anything less than 1 is fine, although looking at 1.1 or 1.2 won’t take me away from the company.

How does PEG work? Let’s say the company has a P/E of 12. And that company has projected annual revenue for the next five years of 12% per year. Then it will have a PEG ratio of 12:12 or a ratio of 1. If the estimated growth rate is 15% per year instead of 12%, its PEG ratio will be less than 1. and here’s why. AP/E 12 is good. Remember, I said I like a P/E of less than 10. The S&P 500’s average is about 18. So you can argue that I am loud. Yeah right. I think the S&P 500 is overvalued—and rightly so, relative to its historical average P/E. I believe the S&P 500’s overall average P/E is going down, and I want my companies to have a good P/E not only by today’s standards but also tomorrow. So we’re back to a P/E of 12 if we’re right, and now you know why. On the other hand, double growth is better than good.

It will be much harder to achieve double the growth in the next five years than it was in the previous five years. If investors like double-digit growth and are willing to pay a premium now, just wait. That payment will be enormous.

I consider a company valued at a P/E of 12 (just above my range of 10) to be slightly overvalued – or, to put it another way, if it’s going for a slight premium over fair value. But if it also sports a PEG of 12:15 (attractively less than 1), the small premium is justified and the company moves from overvalued to fair value.

But PEG’s strength is its weakness. It’s great that it allows you to look into the future of the company, but it does so at the cost of being a little speculative. Remember, the “G” part of the PEG projects growth over a five-year period. The PEG ratio is only as good as this estimate. If the company is performing below the “G” portion of the PEG ratio, you may have hit your cart on the wrong star. Future P/E is less speculative, since it only accounts for 12 months of earnings.

And it’s not just the “G” in PEG that muddies the water. “E” salary is a fairly muddy category. It includes all kinds of nonsense, like tax write-offs, depreciation, one-time payments, and sales. At the end of the day, it rarely equates to the company’s bottom line.

For these reasons, I like EBITDA (Earnings before Interest, Taxes, Depreciation, and Amortization) much better – and I believe that EV (enterprise value) to EBITDA is a much better ratio than P/E.

EV is the company’s market capitalization plus its equity minus its debt. It’s called “enterprise value” because that’s what you would pay for the company if it were sold.

In addition to P/E, PEG, and EV/EBITDA, there is one ratio you should look at: price-to-book (P/B). “Book” refers to total assets or assets minus liabilities. An AP/B less than 1 probably means you’re getting a good buy on the company.

Think about it. At a P/B of 1, the price per share you pay is equal to the net asset value per share. That means everything else you get with the company is free. Business – and the income it generates – is FREE. Future growth of the company? It’s free too. An AP/B of 1 or less is a phenomenal ratio. But anything less than 2 is still considered good. This is what works for me. I start looking at EV/EBITDA. Then I look at the trailing and upcoming P/Es. And so I take PEG and P/B about the same time. The more you drop the company’s value, the better you feel about how much – if anything – it gets discounted. Of course, it makes sense that the riskier you think the company is, the bigger the discount should be.

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