Financial Markets Book Financial Markets For The Rest Of Us
An Easy Guide To Money, Bonds, Futures, Stocks, Options, And Mutual Funds
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by Robert Hashemian

Page 232

more attractive the stock may be. Frequently this value is used by an acquiring company to determine whether a company's sales can justify its price. Many value investors may only consider investing in stocks with the price-to-sales ratio of one or lower. But often today you see stocks with much higher price-to-sales ratios in demand. This is especially true of growth stocks such as those in the high-tech industry where investors may be betting their dollars in hopes of rapid future sales growth. In early 2000 Microsoft, for example, had a prices-to-sales ratio of 25 while GE's ratio was approximately 5. And this ratio for Yahoo was about 200!

Price-To-Earnings (P/E) - This is perhaps the most well known of all ratios, and you may also know it by its acronym: P/E ratio. The P/E ratio is simply the price of a stock divided by the annual EPS (earnings per share) of the company. In other words, looking at a stock's P/E ratio you can determine how many times a company's earnings its stock price is. Many years ago when the stock market was still young, the P/E ratio was adopted as the standard criteria for valuing stocks and it is the most widely used method of valuing stocks to this date. Its popularity is perhaps in its simplicity. Using the P/E ratio one can value a stock based on a company's profits, which is the real reason why investors would (or at least are supposed to) buy a stock in the first place (remember dividends).

Traditionally a stock with a P/E ratio of 5-7 has been considered to have a fair value. A P/E ratio of 5 means that the stock price is 5 times the company's annual per share earnings. Or in other words the market cap of the company is 5 times its annual profits. Stocks with P/E ratios lower than 5 would be considered undervalued and worthy of buying while others above this value would be considered overvalued and should be avoided until either the company's earnings move higher or its stock price moves lower. In today's stock market, however, there are

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Table of Contents
Copyright and Disclaimer
Book Chapters
Table of Contents Copyright and Disclaimer Foreword Money
Bonds Futures Stocks Options
Mutual Funds Retirement Final Words Appendix A

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