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.

This article from investopedia.com states “It’s tempting to think it’s a foolproof tool for making wise stock investment choices. Think again—the P/E ratio is not always reliable. There are plenty of reasons to be wary of P/E-based stock valuations.”

Here is why the P/E ratio is misleading…

In short, the P/E can be Good or Bad no matter what the number is.

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

Low P/E: On the flip side, a low P/E may indicate that the stock has low earnings and the share price will fall.  On the other hand, a low P/E ratio may 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 not provide significant confidence on whether to buy or sell a stock.

Unfortunately, the P/E Ratio presents insufficient data.  The P/E is 2 numbers and 1 calculation. The P/E calculation is the Share Price / EPS (Earnings Per Share). An investor cannot make a rational decision with insufficient data.  Tykr on the other hand looks at over 50 data points and factors important metrics such as Revenue growth rate, Net Income growth rate, EPS growth rate, Free Cash Flow growth rate, Asset growth rate, and Equity growth rate. All critical metrics should be analyzed over the duration of 5 years to determine the overall financial health of a stock. Simply looking at the P/E alone will be misleading.

Here is an article on why using the P/B Ratio on it’s own is also misleading.