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Before we can examine a stock’s Relative P/E (price to earnings ratio), we first need to look at its basic P/E. At Value Line, this is calculated by dividing the recent price of the stock by the total of the last six months of earnings and the next six months of estimated earnings. The resulting figure shows the multiple that investors are currently willing to pay for one dollar of earnings. As is the case with most financial ratios, P/E means very little when viewed on its own, which is why Relative P/E is so important. Relative P/E compares the P/E of an individual stock with the median of estimated P/E ratios of all other stocks in the Value Line universe. A Relative P/E of more than 1.00 indicates that an issue’s P/E is above the median, while a Relative P/E below 1.00 shows that a stock’s P/E is below average.So what does this mean for investors? Stocks with low Relative P/E ratios are comparatively cheap, as investors have to pay less money for the same dollar of earnings than they would for a company trading at a higher multiple. For example, a stock with a relative P/E of 1.30 trades at a 30% premium to the overall market, and a stock with a relative P/E of .70 trades at a 30% discount to the overall market.

To draw even more meaningful comparisons, we suggest that investors also compare an issue’s P/E to the median P/E of its industry peers, as P/E ratios tend to vary widely across different industries. For example, high-growth technology companies operating in the early stages of their industry lifecycles typically trade at much higher P/E ratios than industrial companies operating in mature industries. By looking at the nearby chart, we see that an E-Commerce firm with a P/E ratio of 30 could be trading at an attractive price relative to other stocks in that industry. However, compared to the entire Value Line universe, it may appear overpriced. Finally, in addition to listing a stock’s current P/E and Relative P/E on the top of the Value Line page, yearly figures for both metrics are included in the array to provide subscribers with a historical prospective.

Industry

2008 P/E

2008 Relative P/E

     

E-Commerce

39.1

2.35

Internet

27.0

1.62

Value Line Median

16.6

1.00

Steel (General)

10.1

0.61

Maritime

9.0

0.54