How Do I Know If a PE Ratio is Good?

There are many ways to evaluate a company, but one of the ways is by looking at the P / E ratio. AP / E ratio will help make your decision. If you're not careful, it can come back and bite you in your wallet.

The P / E ratio – the price of a stock divided by the company's annual profits per share – is a guideline used by most investors to value equities. It tells you how much you're paying for each dollar of earnings. Usually the lower the P / E, the cheaper the stock will be.

While P / Es are based on estimated earnings (also known as forward P / Es) are common, they're not always the numbers that are used, some analysts use past earnings. While others may rely on "current year" estimates, which are a mix of actual and projected profits for a given year.

Which is most useful? It depends on what type of company you are valuating Any company that is economically sensitive you would need to use forward P / E, since the company's outlook could change quite quickly. Just look at how the home builders were effected. Yes its risky and analysts are often wrong, but looking back can be just as dangerous (past performance does not really mean anything for the future).

So when you're trying to figure out which P / E is best to use for the different stocks that you may invest in. Make sure you know which measure – future, trailing or current year – you're dealing with. Then, when valuing one stock vs. another, be careful to compare apples with apples. Many times if you're not careful, you could lose a lot of your capitol.

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