P/E Ratio

P/E Ratio means Price to Earnings Ratio. It takes the price of a stock then divides it by the Earnings per Share (EPS). The Price to Earnings Ratio is used for valuation. A higher value indicates that the price of the stock may be expensive. A lower value may indicate the price of the stock may be cheap.

During a recession, the Price to Earnings Ratio of many stocks is below 20 or sometimes below 10. It just depends on how bad the recession is. On the other hand, when the economy is good, the Price to Earnings Ratio of many stocks is above 20, sometimes above 40.

As a guide, multiply the Retained Earnings growth rate by 2 to get the maximum Price to Earnings ratio of a stock. Anything above that maximum means the price of the stock is too expensive.

When the P/E Ratios of many stocks reaches above 40 or when it is above the maximum Price to Earnings ratio, consider selling the stocks and buy Treasuries. Wait for the next recession to come. Expensive P/E Ratios of stocks are an indication that there could be a recession waiting around the corner.

 

Equation

 

Check if the price of the stock is too expensive:

Maximum Price to Earnings Ratio

My Financial Analysis of Stocks

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