PE ratio, stands for the stock price vs. earning per share ratio, is the most commonly used (and mis-used) ratio in the investing world. I saw this PE ratio question at trader168 couple days ago, the question goes like this:
BX P/E: 1.97
MSFT P/E: 21.15
JAVA P/E: 46.01
BIDU P/E: 195.95
VMW P/E: 268.98
Why the big difference on PEs from difference companies? Is that true that we should not compare PEs from different industries? (my take: that’s true)
Is PE a still usable indicator? (my take: yes. If used properly)
I think the thread right below the Question is very good. But I would like to add some of my own thoughts. I think as we get more financial indicators, such as EBITDA, cash flow etc., the good old PE is still revelant. Because at the end of the day, we need to evaluate (whether a stock is expensive or not) by relating to its intrinsic value. Earning is one important factor (if not the most important).
High PE ratio usually means investors are optimistic about the future growth of the companies. Because if the earning holds consistent, it will take 196 years for an investor to get back what he/she paid for BIDU today (assume the currency value does not change, for the sake of simplicity). I believe even the most optimistic investor does not expect he/she live 196 years in today’s world. The expectation is Baidu(BIDU) will grow its earning 100% or more year over year, and eventually the PE will come down to normal level (say 50). I think Jim Cramer’s simple rule for PE is a good one: Cramer says he would buy a company’s PE not exceeding twice its growth rate, e.g., if a company grow 20%, he would buy it if its PE is under 40.
I also like to take one lesson from Peter Lynch, who is a mutual fund legend. In his “One up on Wall Street”, Peter says he won’t buy the hottest company in the hottest industry. That’s usually a company has a high PE, and he used EDS as an example.
If we apply those rules to BIDU, VMW, or HMIN (PE: 200), WX (PE: 100), I think long term investors should stay away from them, for now. For short term investors (or speculators), that’s different. They just need to make sure selling it when the bubble burst.