A downturn in the economy causes investors to panic and scramble when making the wisest investment decisions. During those times, various stocks on the New York Stock Exchange will decline in value. An experienced investor may sell or purchase a stock with a high or low price to earnings ratio to protect their invested capital. If you are a first-time investor, learn about investments in the areas of planning, stock types, economic conditions, strategies, and portfolio diversification. Education is the key to making smart investment decisions regardless if the economy is booming, declining, or stable.
After you educate yourself, invest small in the beginning and buy stocks with a low PE ratio (price to earnings ratio). Companies use ratios to measure the value of their stocks by calculating its share price and dividing it by annual earnings per share. Investors use the analytical results to evaluate the value of an asset and the financial health of a business before they make an investment.
Price Earnings (PE) Ratio Defined
PE ratio is a measurement used by investors to analyze the relationship between the price of stock offered by a company and its earnings per share. The ratio is an indicator of the amount of money each stock costs for every dollar of earnings. It allows an investor to determine what premium to pay for the earnings of a company. You as a first-time investor must make a wise investment decision about the expected growth of that business warranting the premium wagered. The purpose of PE ratios for advanced investors is to determine if a stock is undervalued or overvalued and to use it as an index benchmark or a comparison of the average industry.
How to Calculate Earnings Per Share and Price Earnings
The calculation for earnings per share or EPS is taking the net income after subtracting dividends of a company’s preferred stock and dividing the result by the number of shares outstanding. This formula is helpful in providing you a perception of the financial position of a company. To calculate PE, you will use the annual earnings per share measure.
Financially Plan Before Investing
People serious about building wealth begin their journey through financial planning. They plan to invest as they would plan for a fabulous vacation in London, especially if they live on a budget. Whether you are planning to become an investor or take a trip, you must save money and live within your financial means. London once was one of the most expensive tourist attractions in the world, but its status today is on a decline. You can plan that perfect trip and invest by making adjustments in your spending habits.
Suppose you saved enough money to vacation in London but want the family trip to be economical. For entertainment, go to a museum free to the public and a historical park to reduce costs. Apply the same concept to investment planning and seek cheaper stocks that usually have low PE ratios.
- Common Stocks
- Preferred Stocks
Stockholders of common stock may vote at shareholder meetings and they receive dividends at the end of each quarter. Shareholders of preferred stocks do not have voting rights and receive dividends before a common shareholder. If a company goes bankrupt, they have priority over all common stockholders.
Common and preferred stocks can be value stocks and have a low price to earnings ratio. A value stock may be an income or growth stock. An income stock pays dividends quarterly and a growth stock rarely pays dividends. A technology company is an example of a growth stock and a utility company is an example of an income stock. Investors gamble their capital on those stocks, assuming the market will recover and the price of stocks will increase.
The wisest financial move you can make during these economical times of uncertainties is to plan efficiently and educate yourself on investments. It is essential for becoming a successful investor and building financial wealth and stability. The information provided above on how to calculate the EPS and PE ratio is helpful in measuring and determining the financial position of companies before you invest.