Assigning value to a stock is complex in fundamental analysis. Our Tulsa financial advisors compile a wealth of information to forecast the company’s earnings. If analysts tend to conclude the stock is worth more than the company’s asking price, it is considered undervalued. One of the many methods of fundamental analysis to find these companies is to evaluate the price-to-earnings, or P/E, ratio.
The P/E ratio is the price per share divided by earnings per share. The earnings value is calculated with one of these methods: 12-month trailing, estimated, adjusted, and GAAP.
The Four Earnings Methods
12 months is defined as the last four reported quarters, forecasted earnings are the analysts’ expectations for the year, adjusted earnings account for selling assets or other large transactions, and GAAP earnings are standard accounting practice for the Securities and Exchange Commission filings.
Using the trailing 12 months’ stated earnings, investors use a valuation method of comparing the current share price with actual historical information. This calculation is made every quarter when the company reports its earnings and is not based on forecasts.
Financial advisors may also estimate future earnings for several years. Adjusted earnings account for the changes in operations that affect earnings, such as non-recurring transactions. GAAP earnings is calculated with the rigid, generally accepted accounting standards.
P/E calculations are based on basic or fully diluted shares. Basic shares are the stock held by shareholders, and fully diluted shares are the number of new shares after all securities of the company are converted.
General Limitations of P/E
P/E could either be low or high based on the quality of the earnings. A small change in the forecasts can create wide movements in the stock price, therefore altering the P/E.
More Information
The professional financial planners at First State Investment Advisors are equipped and adept in investment analysis. To build your portfolio, contact the experts in Tulsa today at (918) 492-1361.
This overview is for informational purposes only and is not a recommendation. It should not be the sole deciding factor in making an investment. Investing is a risk and, as with all risks, a positive return is not guaranteed. Past performance does not indicate future results.