[stocks/PE] What does it mean when a stock "trades at 'x' times earnings''?

Question

For example, a stock is worth $20
and is trading at 12 times earning
Does that mean that the company's profits have to increase 12 fold for the each stock to be "really" worth $20 (earnings per share) ?

Answer 1

Every stock that is listed on an exchange represents an actual business that provides goods or services with in the economy. These companies charge for their services and --after paying their expense-- earn a profit; presumedly. Those profits are called earnings and they belong to the shareholders but are managed by the company's executive and board of directors.By law a company that is publicly owned and traded must file their "Financial Statements" of operations for public veiw and scutiny. A company's earnings can be found on their "income and expense Staements.

Investor routinely consider earnings and other metrics like book value as a means to determine a company's "value" in order to determine the "price" they should pay (lately this has become a lost art). The "times earnings" term refers to a comparson of the company's earnings to the prevailing market price. For example: If a company earned $4.00 per share in annual earnings and the current market price is $40.00, it will be said the the company trades at 10 times earnings. That's how many times above the company's current earning production you are being asked to pay for a ownership stake in the company. Put another way, it is the number of years it would take the company to actually earn the amount you are now paying for the stock; provided every thing remained the same. Keep in mind, that things seldom remain the same; they sometimes get better, and they sometimes get worse. Still it should serve as a bench mark for determining if you are overpaying or getting stock cheaply.


Q: Does that mean that the company's profits have to increase 12 fold for the each stock to be "really" worth $20 (earnings per share) ?

Earnings are just one of many metics that should be used to determine a company's "worth". Others like book value and cash flows are also helpful. Here, things like future prospect (growth), contractual signings, goodwill (trademarks, patents, etc.) also come into play. As such, worth determination is as much an art is it is a science. Lately, with the inclusion of technology, more investors have abandon these fundamental metrics for for more technical ones. These methods ignore fundaments (which are "real") and try to profit from determining " pricing patterns"( which is appearance). Resultantly, price is often mistaken for value. Consequently, the markets will often overprice issues and underprice issues because not everyone is using the same metrics. Here you have to rely on your understanding of proper valuations to get you through the rough swings. Eventually, the markets will arrive at a more proper and reasonable price to value ratio.

Answer 2

1

Answer 3

Yes it does. IF the company increased earning 12 times, and then never did any business ever again, the stock price would be worth earnings- what you would expect. Some companies trade at a high multiple because they expect business to grow in the future, and can justify the high multiple. Technology is one such area, Google is a famous sotck that trades at 52 time earnings, because they have certain competitive advantages, including the fact that they have youtube, and the most used search engine on the internet. Certain sectors (like cement manufactures) can't expect to have so many sources of revenue, and might trade at 10 times earnings- which roughly means that although they can be expected to stay in business, there is no reason to expect they will improve too much. Older and established companies cannot grow as quickly as small ones, and so their earning wont grow so much either- a low P/E is the sign of a mature company.

Answer 4

It is just a way to measure it's value compared to other stocks in the same industry. If several stocks in the steel industry were trading at a PE of 12 and another were trading at a PE of 9. there might be an opportunity to invest in the third one and make some money. If there were no good reason for the weaker PE ratio that stocks price might increase faster than the other two.

Answer 5

stockspe stock trades times earnings

Answer 6

Yes. You answered your own question.