What does a low PE ratio indicate versus a high?

Question

Which would you rather invest in and why? Also, what's this thing about having your stocks be negatively correlated? And how do I determine this?

Answer 1

blue chip stocks trade based on their dividends and also based on their earnings...most good stocks trade based on their earnings...So Price to earnings ratio (P/E) is important for evaluating the expeniveness of the stock. For a blue chip stock A P/E of less than 13, indicates that the stock is probably underpriced, whereas a P/E of over 18 would indicate an overpriced position.

For growth stocks, the P/E would probably always be in the overpriced position as the market is valuating the company on what the market hopes it's earnings will be in the future

I like Low P/E stocks because they tend to be a surer way to go (value Investing)

Negative correlation is having some investments that go up in value at different times of the market cycle

In General, Bonds are negatively correlated with stocks, Stocks going up, bonds are probably going down. This smooths out the volitility of your investment portfolio.

The are different sexctors of stocks that rise faster in different parts of the investment cycle (resources, financial services, transports Etc.).... A diversification over many sectors smooths out volatility as well

Answer 2

A low P/E ratio doesn't necessarily mean anything compared to a high P/E. Some people will tell you that it does, but that's an oversimplification.

A P/E ratio is simply the price divided by the earnings per share. If the price of the stock is $20 and the company earns $1 per share, then the P/E is 20 (20/1). However, you have to compare a company to others in its industry to determine if it is expensive or undervalued. For example, it is not uncommon for energy companies and home builders to have very low P/E ratios even when they're doing well. A P/E of 15 might be very expensive in one industry and very cheap in another.

There is no rule that says a particular number is always good or always bad. Compare companies in the same industry. If the average P/E is 17 and one company is 25, then it may be overvalued. Or, it may be growing faster than the industry average, so people are willing to pay more. If the average is 17 and one company is 10, then it may be undervalued. Or, it may just be a badly run company and it has a low P/E because its prospects are poor. Look at factors other than earnings, such as sales and cash flow. Earnings can be easily manipulated to look good by unscrupulous companies. Sales and cash flow are more difficult to play games with.

By negative correlation, I think that you are referring to holding assets that don't move closely in tandem. (I think that you may mean "low correlation".) For example, if all of your assets are large cap stocks, they will tend to move in tandem with the stock market. However, adding other types of assets can reduce risk because they may zig when your other holdings zag. Small cap stocks and international stocks may move somewhat differently than large caps. Bonds will not necessarily move in tandem with stocks. As an extreme example, precious metals may have little correlation with stocks.

Correlation to an index is measured by a calculation called R2. It's not measure by beta, as another person wrote. Beta is a measure of volatility, not correlation. They're not the same.

Answer 3

That depends on the kind of trading/investing that you are comfortable with. Growth/Momentum traders usually go after higher PE stocks, but also they don't hold stocks for long periods.
Also in a bullish market, higher PE stocks can go up very quickly, but they can drop quicker too in correcting or bearish markets.

In the long run, if you buy lower PE stocks a la Buffett or value investors you can do well. Growth investors will say Low PE stocks are cheap for a reason, but their portfolies will undergo more volatility than the Low PE investors usually will.

Answer 4

Stocks trade on expectations. Since PE reflects growth prospects, a low PE implies slow growth, and vise verse.

Value investors buy low PE stocks on the premise they are selling at a discount. Growth investors buy high PE stocks because the faster the growth, the sooner the stock can double.

Negative correlation is when your stock is down when the market is up and vise verse.

Answer 5

What Does Pe Ratio Mean

Answer 6

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Answer 7

This is a link to an article about Beta:

http://en.wikipedia.org/wiki/Beta_coefficient

The Beta coefficient of a stock indicates how the stock is correlated to all the other stocks in the stock market. A stock with a beta of 1 moves directly with the stock market and in proportion to its changes. A stock with a negative beta moves in the opposite direction of the rest of the market. There's a little bit about negative beta in the article that I referenced.

P.S. Here's an article about price/earnings ratios:

http://en.wikipedia.org/wiki/P/e_ratio

Answer 8

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