PE ratio DOES it Really WORKS???

(investors friend) In investing as in most areas of life, a little knowledge can be a dangerous thing.

Most investors have a rough understanding that low Price to Earnings ("P/E") stocks are or might be bargains and that high P/E stocks are expensive. Most investors also understand that high growth stocks usually have a higher P/E.

Unfortunately, most investors have very little understanding of exactly why this is and exactly how the math works. Therefore, most investors are not in a position to judge when the P/E of a stock is too high and when it truly is a bargain.

The P/E ratio can only be used to value stocks for which a representative initial earnings per share is available.

- The earnings must be adjusted for unusual gains and loses. Never apply the P/E ratio to judge if a stock is a bargain without checking if the earnings are abnormally high or low due to some unusual or one-time items. The use of a P/E ratio to judge a stock implicitly assumes that the earnings provide a sustainable basis from which to forecast future earnings.
- P/E is of little or no use for very cyclic or commodity linked stocks since we can not judge if the initial earnings are in any way indicative of future earnings
- P/E is of little or no use for start-up companies since the earnings will not have reached a stable representative level
- P/E ratio is of most use in cases where a company has a history of stable earnings or stable growth which is expected to continue in the future.