This is the first video in our new video series, Investing: Explained. SprinkleBit CEO, Alexander Wallin, will introduce basic investing topics, discuss why they matter and how to use them.
So, without further adieu, check out the video below about how to analyze a company using PE. What say you, SprinkleBit Nation?
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Today we’re going to learn how to analyze a company using PE. And we’re going to do it in four parts. (Cue Megaman 2 theme – yes!)
We’re going to start with:
- ‘What is PE’,
- ‘Why does it matter?’,
- ‘How do we calculate it’, and
- ‘How do we use it?’
The technical term is “Price Earnings Ratio.” You take the Price divided by the Earnings.
Price is the market value per share. What you actually pay when you buy a share. For example, you pay $466 for one share of Apple.
Earnings, or Earnings Per Share (EPS). To get EPS you look at the revenue coming into a company and then all the cost that the company has; marketing, production, etc. You’re left with the profit which is called the ‘Net Income’ which then gets distributed into the number of shares, and that is your EPS.
So what is PE?
PE is Price divided by Earnings. (Applause)
Why does [PE] matter?
PE matters because it should be the first step for anyone looking into buying a share or selling a share. It’s quick and easy and it’s fairly accurate.
So how do we calculate [PE]?
We already know that PE is Price divided by Earnings. So for example, Apple has the ticker AAPL, that’s how you can find it. They have a price of $466 per share … (aaaand motorcycle interruption)
… their EPS for the last 4 quarters, sum it up, is $44.1. Most sites will give you this and they call it’s called the ‘Trailing 12 Months’.
So if the price is $466 and the EPS is $44.1, the PE is 10.56. ($466 / $44.1)
So now when we have that Apple’s PE is 10.56, how do we use this number?
How do you use PE?
With industry average PE, you can have low, medium, or high PE. And this is all correlated to the expected growth of the industry as a whole. A good example of high industry PE is technology. Medium industry PE is banking. And low industry average PE is utilities.
Utilities for example, that would be like you paying for your electric bill. Low expected growth, low average PE.
Technology, however, you have an expected growth that’s much quicker than banking or utilities. That’s why you have a higher industry PE.
So, average technology PE is roughly 20. Apple’s PE is 10.56. So, according to our calculations today, Apple’s PE is below the technology industry average. Anything that is below the industry average is considered undervalued and anything that is above is considered overvalued. And this is one way to use PE to analyze a company.
By looking just at the PE and the industry average, you can see that Apple is undervalued.
Thanks for watching and if you want to learn more about PE and other ways to use it, we’re going to have tons of that at SprinkleBit University. I’m looking forward to chatting with you there.