I have seen some people (who should know better) remarking in print that investors should search for stocks with a low P/E ratio. The P/E ratio is the ratio of Price (current stock price) to Earnings (profit after tax available for distribution to shareholders, from the most recently issued financial statements). Recommending that you look for low P/E's must stem from the thought that the market is setting an unrealistic 'P', and that therefore these shares are 'cheap'. However, realize that the market is only occasionally, very rarely, wrong about the 'P'. The more likely reason for a low P/E is worry about the sustainability of the 'E'. Thus a P/E of 5 would indicate that it would only take 5 years to recoup your investment at the rate of last year's earnings. This seems like a bargain, but the catch is in the italicized phrase - the market doesn't believe that last year's earnings can be sustained. If you think you've spotted a bargain, do more research - read everything you can find to understand why the market is marking this stock down, and then if you disagree, by all means buy.
Copyright © 2011 Mick Brooks