How is knowing the P/E ratio useful when investing?

Hi,

PE ratio is only use for valuing a certain type of companies. It is only useful to a certain extent. To learn how to analyse the company is then the most important thing when it comes to investing.

Like the others have mentioned, PE ratio is a useful multiple commonly utilised by most investors. But I would suggest you look at the PEG multiple too.

PEG stands for P/E divided by Earnings Per Share Growth over a period of time. The PEG ratio takes into account not just how much a share is worth relative to its earnings (definition of PE), but also its growth rate, since growth also affects a share's value. In essence, a firm's PE should be positively correlated to the EPS growth rate. The higher the EPS growth rate, the higher the PE multiple you will be paying.

The PEG multiple can help us decide what shares are over or undervalued. If the PEG multiple is low, this means that a company's EPS is growing faster relative to its PE, which means that the market may be undervaluing this share (since higher EPS growth rate should lead to higher PE). The converse can also be true, where the company's EPS growth rate is low but the market still values the company's share highly which leads it to a higher PEG. Such shares are then considered overvalued.

Like others have mentioned, you need to pay attention to whether EPS growth that the multiples are trading on are trailing (historical) or forward (prospective)