Just as there are three types of profits - gross, operating, and net - there are also three types of profit margins that can be calculated to offer insight into a company's profitability. Gross margin is simply gross profits divided by revenues, and so on. Margins are usually stated in percentages.
Gross Margin =Gross Profits / Revenues
Operating Margin = Operating Profits / Revenues
Net Margin = Net Profits / Revenues
Price / Earnings and related ratios
One of the most popular valuation measures is the price / earnings ratio, or p/e. The p/e es the price of a stock divided bhy its EPS from the trailing four quiarters. As an example, a stock trading for $15 per share with earnings of $1 per shareduring the past year has a p/e of 15.
p/e = Stock Price / EPS = Market Capitalization / Total Company Profits
The p/e ratio gives a rough idea of the price investors are paying for a stock relative to its underlying earnings. It is a quick and dirty way to gauge how cheap or expensive a stokc may be. Generally, the higher the p/e ratio, the more investors are willing to pay for a dollar'sworth of earnings from a company. High p/e stocks (typically those with a p/e above 30) tend to have higher growth rates and / or lesser future prospects.
The p/e ratio can also be useful when compared with the p/e of similar companies to see how the competitors stack up, In addition, you can campare a company's p/e with the average p/e of the s&p 500 or some other benchmark index to get aroungh idea of how richly a stock is valued relative to the broader marker.
Watch the "E" in P/E
The "E" part of EPS and p/e can be tricky. Sometimes a company can incur one-time expenses that temporarily take a big bite out of earnings and jack up the p/e. Also, make sure you're using comparable "Es" forward p/e is another very common ratio that calculates p/e using a consensus of Wall Street'sprojected earnings for the current fiscal year. A company's forward p/e will be lower than a trailing p/e if a company's earnings are growing from year to year.
One useful variant of p/e is earnings yield, or EPS divided by the stokc price. Earnings yield is the inverse of p/e, so a high earnings yield indicates a relatively inexpensive stokc while a low earnings yield indicates a moreexpensive one. It can be useful to compare earnings yields with 10 or 30 year Treasury bond yields to get an idea of how expensive a stock is.
Earnings Yield=1/p/e ratio = EPS / Stock Price
Another useful variant of p/e is the PEG ratio. A high p/e generally means that the marker expects the company ro grow its profits rapidly in the future, so a much greater percentage of the company's potentialearnings are in the future. This means its marker value (which reflects those future earnings) is large relative to its present-day earnings.
The PEG ratio can help you determine if a stock's p/e has gotten too high in these cases by giving you an idea of how much investors are paying for a company's growth. A stock's PEG ratio is its forward p/e divided by its expected earnings growth over thenext five years as predicted by a consensus of Wall Street estimates. For example, if a company has a forward p/e of 20 with annual earnings estimated to grow 10% per year on average, its PEG ratio is 2.0. Again, the higher the PEG ratio, the more relatively expensive a stock is.
PEG=Forward P/E Ratio / 5 Year EPS Growth Rate
Warning on PEG
As with other measures, the PEG ratio should beused with caution. PEG relies on two different Wall Street analyst estimates - next year's earnings and five - year earnings growth - and thus is doubly subject to the possibility of overly optimistic or pessimistic analysts. It also breaks down at the extremes of zero - growth companies.
The price/sales (p/s) ratio is figured the same way as p/e, except with a company's...