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Make Smarter Investments by Mastering This Simple Ratio

Damian Davila — Tue, 11 Apr 2017 09:00:08 +0000

When doing your research on what stocks to invest in, you will undoubtedly hear analysts and financial pundits mention something called a P/E, or price-to-earnings, ratio. This is one of the key numbers in a stock table, and one you'd be wise to brush up on. Let's review what the P/E ratio shows, how investors use it to evaluate a stock, and some guidelines to make the most of it. (See also: Beginner's Guide to Reading a Stock Table)

What is the P/E ratio?

It's the ratio of a stock's market value per share to its earnings per share (EPS). Generally, the EPS is from the last trailing 12 months (TTM). However, some financial analysts may use an EPS figure from a shorter trailing period, such as one or two quarters, or a future period, such as over the next six to 12 months.

This is why it's important to pay attention to whether a P/E ratio calculation is using historical or projected numbers. Estimated numbers are subject to a margin of error and will be updated as new data becomes available.

A P/E ratio tells you how much investors are willing to pay to receive $1 in return for investing in a stock. Historical data suggests that on average, investors are willing to pay $15 for every dollar of earnings (a P/E ratio of 15). However, P/E ratios can vary across industries and particular companies. On March 10, 2017, the P/E ratios of Facebook Inc. [Nasdaq: FB], McDonald's Corporation [NYSE: MCD], and Toyota Motor Corp. [NYSE: TM] were 39.95, 23.36, and 10.70, respectively.

How investors interpret the P/E ratio

The main appeal of the price-to-earnings ratio is that it provides a single, standardized metric to an investor evaluating whether or not a stock is worth buying (or selling).

However, any P/E ratio is open to a lot of interpretation.

High P/E ratio

On one hand, a high P/E ratio could indicate that investors are expecting a company to grow its future earnings. On the other, it could be a signal of "irrational exuberance" — a term coined by former Fed chairman Alan Greenspan to refer to unsustainable investor enthusiasm. (See also: 3 Pearls of Financial Wisdom From Alan Greenspan)

With a P/E ratio of 331.23 (no, that's not a typo!) as of March 10, 2017, Netflix, Inc. [Nasdaq: NFLX] is open to both interpretations. One investor could argue that the future of media is online streaming and that this company is making all the right moves to become a leader in this industry. Another could argue that this market valuation is a bit out of whack.

Low P/E ratio

While one investor may think that a low P/E ratio indicates that a stock has seen better days, another investor may interpret that same low P/E ratio as a chance to snap up some shares at a low price.

Shares of Apple Inc. [Nasdaq: AAPL] provide a great example of this scenario. With a P/E ratio of 16.66 as of March 10, 2017, some investors may think the performance of Apple is just slightly above average (remember the long-term average of 15). Other investors may think that this is just a slow period and that it has room for growth since its maximum P/E ratio for the last five years is 18.51.

How to make the most out of the P/E ratio

Now that you know what it is, let's turn to putting it to work.

1. Don't rely solely on the P/E ratio

Due to the math behind the P/E ratio, publicly traded companies that are losing money don't have a P/E ratio at all! For example, the hottest talk of the investing world right now, Snap Inc. [NYSE: SNAP], doesn't have one. So for now, their P/E ratio is irrelevant, and you should rely on an alternative valuation metric, such as the price-to-sales ratio.

2. Put the P/E ratio in perspective

It's a smart practice to measure a stock against a group of comparable peers. For example, you could compare the P/E ratio of Marriott International Inc. [Nasdaq: MAR] against that of Hyatt Hotels Corporation [NYSE: H], Wyndham Worldwide Corporation [NYSE: WYN], or the average of the ones from several others within the same industry.

Another way to put that P/E ratio into context is to use its historical average, maximum, and minimum. By taking a look at these numbers and evaluating the decisions from management, you can have a better understanding of the current ratio.

3. Pay attention to the P/E ratio with buy recommendations

If you receive recommendations from your friends, relatives, or favorite TV pundits that you should buy a particular stock because it's "going places," pay attention to the P/E ratio. If a stock price rally is a rocket, the P/E ratio is the fuel that helps it take off … and keep rising. Without a high enough P/E ratio, a rally will be short-lived or, even worse, turn the other way around.

4. Beware accounting shenanigans

Companies with one-time events, such as selling off a major division or cutting down employee benefits, can alter their earnings and, as a result, their P/E ratios. Dramatic ups and downs in the P/E ratio would render this ratio useless and you'll have to use an alternative stock valuation metric.

This is why it's a good idea to keep an eye on current (also known as trailing) and forward P/E ratios. A big difference between these two P/E ratios is a sign that there was a one-time event. Analysts suggest that when there are too many instances of these gaps, investors should pay closer attention to the cash flow statement on company filings.

P/E ratio is no silver bullet

While the P/E ratio can be a useful metric to select stocks, it's no silver bullet. This is why it's important to continuously educate yourself about the inner workings of the stock market and seek the advice of a financial adviser whenever appropriate. (See also: Who to Hire: A Financial Planner or a Financial Adviser?)

This article is from Damian Davila of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Is Your Marketing Campaigns Working?

JoAnne Berg — Wed, 15 Jun 2011 21:23:43 +0000

Link:

http://www.openforum.com/articles/is-your-marketing-campaign-working

Sales and marketing costs are among the largest expenses in running a business, yet they can be the hardest ones to evaluate.

How do you know if the time and money you are spending on marketing and sales is improving your bottom line? The truth is that ROI (return on investment) for marketing and sales spending is notoriously difficult to calculate. But it is possible to determine if your overall approach is working, and you can analyze your costs over time to get a picture of whether or not your efforts are effective. You can also track separate campaigns and see which ones result in a boost in sales.

To start with, let’s define these two terms.

Marketing is any activity that creates a prospective customer (a prospect).
Sales is an activity which turns a prospect into a buyer — a customer.

Analyzing the Effects of Your Marketing and Sales Spending

It is important to keep track of these two activities separately so that you know how much you are spending on each category. That’s the first step: set up your accounting systems so that you can easily see how much you spend for marketing, and how much for sales activities. If you run separate marketing campaigns, it’s wise to track the expenses of each one separately as well.

The second step is your sales reporting. It’s critical to be able to track your sales on a daily, weekly, and monthly basis, and compare them to last week, last month, and the same week and month last year. You will also want to compare them to your sales goals to see how you are doing. Otherwise, you won’t know if your numbers are going up or down. Those comparisons are critical.

Enter all these numbers into your trusty Excel to prepare a line chart of your expenses (marketing and sales separately) and sales revenue over time. Do you see a trend? When you ran that special campaign 6 months ago, was there a corresponding boost in sales revenue (it could be a bit down the line, say 30-60 days)? This will allow you to see any trends or patterns in sales revenue that is affected by your sales and/or marketing strategy.

Of course, increasing your sales is not the actual goal of your marketing efforts — increasing profits is the goal. So, it’s important to make sure that the sales you are gaining are profitable sales. To do this, add a line to your graph for gross profit, and you will get the picture very quickly.

What about the Value of Your Time?

For many of us, especially those of us in service businesses, our marketing and sales efforts are more personal — they are mostly made up of our time doing networking, communicating via social media, talking to potential clients, etc. There’s no “cost” for this reflected in our accounting systems — but it is a real cost, and it’s important to know if your efforts are effective.

Here’s a suggestion that has worked for many of my colleagues and clients. For 90 days, commit to recording your time and tracking how many hours you spend on each marketing and sales related activity.

Then, graph the number of hours that you spend each week for each category that you are active in. Don’t just lump it all together — break out networking, social media, etc. separately so you can see what is working and what is not.

On the same graph, record weekly billings, weekly new client proposals, or whatever metric is most meaningful to you, and compare that trend with you are spending your time. This is a great way to see if you are getting the most out of your efforts and will let you know where to spend more time and where to spend less.

It takes Money to Make Money

Marketing and sales efforts are a critical part of the success of any business, and they’re often one of your biggest costs. The trick is to spend time and money on the activities that really make a difference to the bottom line. Over time, these graphs can be invaluable in making sure you do just that.

This article is from JoAnne Berg of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Is The Knowledge You Have About Your Business Unsatisfactory

Ken Kaufman — Sat, 07 May 2011 23:14:26 +0000

Link:

http://www.openforum.com/idea-hub/topics/managing/article/is-the-knowledge-you-h...

Lord Kelvin, the British Physicist and founder of the absolute value temperature scale, taught that the inability to express knowledge in numbers renders that knowledge meager and unsatisfactory. Is the knowledge you have about your business meager and unsatisfactory?

The One-Employee Show

If you start a business by yourself and you have just one customer that buys just one product or service from you, it’s pretty easy to track your business performance. You do not need to consult a management team, reports, or mounds of data to understand where you are and where you are going. You know every day-to-day detail of your business, and you rely on your first-hand knowledge to influence the decisions you make.

Introducing Complexity

Adding new employees, customers, and products and services to your business makes understanding performance trickier. The more complex a business, the more difficult it is for one person to be intimately involved with all of the day-to-day details on a first-hand basis. A CEO or business owner has to start to rely on what their employees, customers, and vendors tell them about the performance and health of the operations.

The Gut

As this complexity increases, the primary decision-maker in the business begins to rely more and more on his or her “gut”, which is intuition developed through experience, to interpret information from various sources related to the company. Without concrete, first-hand information, many entrepreneurs and founders feel like they are left to make decisions blindly, not sure if they are taking the company in the best and most beneficial direction.

The Numbers

There is a way to overcome this doubt and turn uninformed, anecdotal, gut-based decision-making into well-founded, confident decisions. It is a process of using numbers to understand and improve performance. But I’m not talking about just any kind of numbers, because often data and numbers can leave a business owner more confused than actually foster clear, strategic, actionable knowledge.

Best Decisions Possible

Gut instincts are the base of the decision-making process. When you introduce raw data to these instincts, it has little impact. But when you turn that data into information through some basic organization and analysis, it starts to make a difference. And, when you synthesize that information into the context of where you’ve been, where you are, and where you are going, it empowers you to make the best decisions possible for your business. Good decisions lead to improved profitability and cash flow, making the proper use of numbers extremely important to business owners.

Bad Information and Bad Consumers of Information

Not all data and analysis have a positive effect on decision-making, for two reasons. First, the data may not be worthwhile. It may be out-of-date, inaccurate, or not focused on the pivotal performance drivers of the business. Second, the person consuming the information may not know how to process it and what to do with it. In almost every company I have known, it is a combination of both.

Common Barriers

These two problems can be solved, but not without some effort. Here are a few of the common barriers entrepreneurs face when trying to use numbers to run their business:

Not knowing what to track in the first place;
Untrained or unskilled staff;
Poor processes and procedures;
Unleveraged technology and software;
Out-dated information;
Not knowing what to do with the data once they have it.

The Solution

The end goal is to have the right information in the right hands at the right time in the right format in the right context. Study after study shows that when companies solve the barriers to properly using numbers to run their business, performance improves. In fact, two independent studies specifically identified that about 90% of businesses that implement the use of numbers correctly saw a moderate to very high improvement in performance. The authors of The Balanced Scorecard specifically identify the need for measurement systems to survive and prosper in information age competition.

Measurement Systems

I don’t know who first coined the phrase “that which is measured improves,” but they must have owned a business at some point in their life. Just the act of measuring brings value, but a system that allows you to understand your past, present, and future performance quickly becomes a fix for so many problems facing businesses today. And the right measurement systems have a way of uncovering overlooked opportunities, inefficient use of working capital, and so much more.

Is it Worth All the Effort?

Have you ever felt that measuring and tracking things is an unnecessary expense, an impediment to getting more customers and growing a business? Maybe it just seemed too time consuming to be worth all the hassle. I would encourage you to consider changing your opinion on this issue as quickly as possible. If done right, knowing the numbers of your business will bring strategic insights you never considered and competitive advantages you never imagined.

This article is from Ken Kaufman of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread: