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, we prefer to buy stocks when their P/E Ratio is below 18. If the P/E Ratio goes below 10, we have to be careful and make sure that the company isn't going out of business. Once we have determined the company isn't going out of business and the P/E Ratio is below 10 and there is also massive potential for growth in the company's earnings in the future, then that stock would be a big Christmas gift.

During a market boom, when the P/E Ratios of many stocks reaches above 40, consider selling stocks and buy Treasuries. Wait for the next recession to come. Expensive P/E Ratios of many stocks are an indication that there could be a recession waiting around the corner.

Equations

Consider buying the stock when:

Consider selling the stock when: