4 Keys to Picking Great Stocks (Part 1 of 4)
First, let’s knock out the definition of Price to Earnings ratio. The formula is simply the stock price divided by the earnings per share (EPS). It basically tells you if the stock is cheap or expensive, but the answer to that question depends on your perspective.
The price to earnings ratio can tell two sides of the same story. It really depends if you call yourself a “Value Investor” or a “Growth Investor”
If you are a value investor, you believe that a low price to earnings ratio (or simply PE) means you are buying a stock at a discount. You typically don’t want stocks if their PE is over 25.
If you are a growth investor, the higher the PE the better. A growth investor says “if the stock is any good, then it will have a high PE because if people want to buy it, it will naturally drive up the price relative to its earnings”
I think the graph below is helpful.