Q: Does a low P/E ratio mean that a stock is going to go up?
- T.S., Orono, Maine
A: Not exactly. A price-to-earnings ratio is a simple fraction, dividing a stock's current price by a year of its earnings per share (EPS). Thus, if a stock is trading for about $50 per share and has a trailing EPS of $2, its P/E ratio is 50 divided by 2, or 25.
The number gives some perspective on the attractiveness of the stock's price, because it shows how much you're paying per dollar of earnings. Thus, all other things being equal, a P/E of 10 is preferable to a P/E of 20, because you'd be paying a lower "multiple" of earnings.
A P/E doesn't show whether a stock will go up, but a steep P/E might reflect an overvalued stock that's more likely to stall or decline than to keep rising. And a low P/E can reflect a bargain.
* P/Es vary by industry, so expect low ones in, say, manufacturing, and high ones in software and fast-growing businesses.
* P/Es rely on EPS, which can be manipulated to some degree by management. So be sure to evaluate other measures, too.