What is the PE-Ratio and why is it important?
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Imagine the following scenario:
You buy a stock of a company for $100. This company has a PE-Ratio of 10. You hold this stock for 10 years, then sell it. But the unexpected happens! “Oh shit, the price of that stock dropped by 50%, omg I have to sell my stock for $50, I LOST HALF MY MONEY!!”
This is something that could happen when you buy stocks on the stock market.
But what if I told you you didn’t actually lose $50, but instead gained $50?
“That you’re an idiot.”
Let’s take a look at the second sentence of this post: “This company has a PE-Ratio of 10.”
“Cool bro, but the stock price fell by 50%”
Yes bro, but the company has a PE-Ratio of 10.
“Cool bro, but the fuck is that and why should I give a shit, I lost half my money.”
No, you didn’t bro. Buckle your seatbelts, here’s why.
Before you continue reading, please beware that this article is in no way financial advice, it’s for entertainment only. I’m literally a high school dropout sleeping in my parent’s living room wasting my life away running meme pages on Instagram, so for the sake of your own money do your own research. Also don’t sue my ass, gracias.
What is the PE-Ratio?
In the financial world the PE-ratio is the ratio between Price and Earnings.
- Price = price of a stock
- Earnings = how much dividends owning that stock earns you per year
Wait what, I get paid for OWNING a stock?
Congrats, you got it. This doesn’t apply to all companies (for example it didn’t for a long time for Amazon), and usually only to companies that make a profit (otherwise they’re shooting themselves in the foot, duh).
But to most “normal” companies listed on the stock market this applies, they pay you dividends for owning their stock(s).
How much?
That differs, mainly because companies heavily differ in “size”, revenue, profit, employee numbers, industry they’re operating in, etc etc.
Duh, but then how do I compare company A and B?
Here’s where the PE-ratio helps you. It basically tells you how many years, after buying a stock, you have to wait till it paid for itself.
Let’s take the example from earlier:
You bought a stock for $100. The company has a PE-ratio of 10.
=> after 10 years the company has paid you dividends that combined make $100.
Ergo, if a company has a PE-ratio of X, after X years the stock has paid for itself, and from then on owning the stock pays you a profit.
And yup, you still OWN the stock, meaning if you sell it that money is yours, too.
That’s why, when buying stocks, you shouldn’t only gamble whether the price of the stock will rise or fall, because even if it goes down 90% within 10 years, which is insane, you’d still make a profit if that company had a PE-ratio of 10.
“Omg, this sounds awesome, let’s buy stonks!”
It *is* awesome, why do you think nearly every financially-well off person owns stocks? They all know and understand this.
Now before you go and put your life-savings into the stock market, which most likely won’t be much if you read an article that explains the most fundamental ratio of the stock market, beware that
- there are heavy risks involved in investing into the stock market, and
- chances are if you read this article and what I just told you was new to you you actually have no clue and definitely shouldn’t just throw money into a mystical machine hoping it throws more money back at you :)
But yeah, more or less that’s it.
You take the earnings from owning a stock/share and compare it to how much that stocks costs.
Here’s another cool pic to look at:
Fun fact, the PE-ratio of Tesla at the moment is about 1250.
“Sounds like a lot.”
It is. The mean average PE-ratio of the S&P 500 since 1880 has been 15. Ergo, from dividends alone whatever money you threw into the machine doubled within 15 years (ignoring basic financial “things” like inflation, stock price changes, blabla).
Both the PE-ratios of Porsche and Volkswagen Group are between 6 and 8. The one of Toyota has been around 10 for years, now currently is at 15. Just to throw a comparison to other car manufacturers out there.
Apple’s current PE-ratio is 35, Facebook’s PE ratio has been hovering between 20 and 30 for the past few years and Alphabet (Google’s mother company) is currently at a PE-ratio of 36.
Again, none of this was supposed or intended to be financial advice, do your own research.
Anyways, that’s it from my side, if you got any questions let me know in the comments or DM me on Instagram @mbtimemesdaily. Peace ✌
