A popular indicator of a stock's growth
potential is its
price-to-earnings ratio,
or P/E. Calculated by dividing a stock's current price by its earnings
per share, the P/E — or multiple — can help you gauge the price of a
stock in relation to its earnings. For instance, a stock with a P/E of
15 is trading at a price 15 times higher than its earnings.
A low P/E may be a sign that a company is
a poor investment risk and that its earnings are down. But it
may also indicate that a company is undervalued by the market
because its stock price doesn't reflect its earnings potential.
Similarly, a stock with a high P/E may live up to investor expectations
of continuing growth, or it may be overvalued.
Debt problems
While the P/E ratio can help you evaluate
the cost of a stock, it's not the only factor to consider.
You'll also want to look at the price and earnings in relation
to the company's
net asset value, or book value — its net assets divided
by the number of its shares and bonds in the market. This information,
which you can find in analysts' research reports, or in the
company's 10-K or annual report, can help you gauge how much
debt a company is carrying. Too much debt can limit potential
growth.
