Calculation Guidance 3 – P/E Ratio

Before we dive into more calculations on Tykr, we want to give you little context on misleading calculations.

A lot of investors use the P/E (Price to Earnings) Ratio to determine the value of a stock. The P/E can be a useful calculation in finance but it should not be the single reason why you buy or sell a stock.

Here is why the P/E ratio is misleading…

Generally speaking, a high P/E indicates that investors expect higher earnings and therefore the share price will rise.  On the other hand, a high P/E ratio can also indicate the stock is overvalued.

On the flip side, when a company’s stock has a low P/E, it may indicate that the stock has low earnings and the share price will fall.  On the other hand, a low P/E ratio can also indicate the stock is undervalued.

Overall, P/E Ratio can be good or bad, no matter what the number is.  That doesn’t help you or I.  The P/E Ratio does note provide significant confidence on whether to buy or sell a stock.

If you’ve ever seen the movie, Moneyball, it’s like drafting a baseball player because he’s “handsome” or because he has a “good swing.”  That information provides no logic on how to win games. In other words, its insufficient data. As you learn in the movie, winning games is broken down to who is able to get on base most often. If a player can get on base, he can score more points, and the team can win more games. The key is who can get on base most often. The more players on the team that can get on base, logically means the team will score more points, and in the end win more games. The math proved to work and the strategy applied by the Oakland A’s in the early 2000’s was adopted by the majority of baseball teams thereafter.

Unfortunately, the P/E Ratio is insufficient.  There aren’t enough data points to make a logical decision.  The P/E is 2 numbers and 1 calculation. When you keep reading the other calculation articles, you’ll learn how Tykr compares.

Equation:  Share Price / EPS

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