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How important is the P/E ratio to my shares?

How important is the price/earnings ratio of a share in influencing your buy or sell attitude to a stock? There seems to be conflicting views.  

The P/E ratio is just one measure you can use to get the right number of ticks or crosses on a stock before you buy or sell. The share price is compared to a company’s earnings and so if the number is 10 it indicates that if the company is any good it could return 10 per cent. If it has a P/E of 20, the return is around fice per cent, that is, 100 divided by 20 equals five.

Now a company doing really well and heavily supported by share buyers can see the share price bidded up and the P/E can rise from say nine to 20 but that does not mean you have to sell it.

If speculation is the main driver, and this happened with internet companies before the Dot.com Crash of the stock market, then a high P/E can be a reason to get out.

However, recently a stock analyst looked at Ramsay Health, which had a P/E of 17.5 based on a 2011 consensus of earnings and while this was high, the analyst pointed out the high valuation was a reflection of the quality of the company and the positive outlook the company had as well.

Become an expert on this measure but also learn how to evaluate the quality of a company using other measures and by doing some good old fashioned research into the management, the prospects for the industry and what is the uncommon offering of the company.

For advice you can trust book a complimentary first appointment with Switzer Financial Services today.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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Published on: Friday, April 22, 2011

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