1. Stock Market Terms Updates for the previous lectures

2. About PE Ratios  The PE of a stock describes the price of a share relative to the earnings of the underlying asset. The lower the PE, the less you have to pay for the stock, relative to what you can expect to earn from it. The higher the PE the more over-valued the stock is.

3. About PE Ratios  For example, if a stock is trading at $24 and the Earnings per share for the most recent 12 month period is $3, then the PE ratio is 24/3=8. The stock is said to have a PE of 8 (or a multiple of 8). Put another way, you are paying $8 for every one dollar of earnings.

4. Why look at the PE Ratio?  The main reason to calculate PEs is for investors to compare the value of stocks, one stock with another. If one stock has a PE twice that of another stock, it is probably a less attractive investment.  But comparisons between industries, between countries, and between time periods are dangerous.  To have faith in a comparison of PE ratios, you should be comparing comparable stocks.

5. My stock has a PE Ratio of 100. What does that mean?  The market expects the earnings to rise rapidly in the future. For example a gold mining company which has just begun to mine may not have made any money yet but next quarter it will most likely find the gold and make a lot of money.  The company was previously making a lot of money, but in the last year it had a special one time expense (called a "charge"), which lowered the earnings significantly. Stockholders, understanding (possibly incorectly) that this was a one time issue, will still buy stock at the same price as before, and only sell at at least that same price.

6. My stock has a PE of 100 (cont)  Hype for the stock has caused people to buy the stock for a higher price then they normally would. This is called a bubble. One of the most important uses for the PE metric is to decide whether a stock is undergoing a bubble or an anti-bubble by comparing its PE to other similar companies.  The company has some sort of business advantage which seems to ensure that it will continue making money for a long time with very little risk. Thus investors are willing to buy the stock even at a high price for the peace of mind that they will not lose their money.

7. My stock has a PE of 100 (cont.)  A large amount of money has been inserted into the stock market, since there are only a limited amount of stocks to buy, supply and demand dictate that the prices of stocks must go up. –This factor can making comparing PE ratios over time difficult.