Understanding P/E Ratios

  
     Many people are uncomfortable with the unfamiliar and math.  They are more comfortable with the things they know.  Price earnings ratios are a way to measure whether a stock is a value or not but many people are uncomfortable with the math of it.  We recently presented the concept of equating the price earnings (P/E) ratio to interest rates. 

     Most people know about high and low interest rates because they buy certificates of deposit (CD).  They liked 8% better than 3%.  P/E ratios are the inverse of an earnings yield that is calculated by dividing the P/E ratio into 1.  An example P/E of 20, divide 20 into 1 and you get 5%.  In a P/E of 10, divide 10 in to 1 to get 10%.  If the P/E is 50, it equals 2%.  Who would want a 2% yield for any length of time? 

     Low yields are yields to be traded rather than held long-term.  Too high of a yield could be a sign of trouble and should be researched as to why it is high.  lf you have problems understanding P/Es and value, try thinking in interest rate terms.