Price-earnings ratio vs. expense ratio

- So you've decided how you want to diversify your assets but how do you know what stocks or funds to pick in the stock market? Let's dive into the meaning and use of a price-to-earnings ratio and an expense ratio. Both of which will help you determine if an investment is a good idea. The price-to-earnings ratio otherwise known as a P/E ratio is one of the most widely used analysis tools to determine a stock valuation. It shows whether a company's stock price is overvalued or undervalued and could reveal how a stocks valuation compares to it's industry group or to a benchmark like the S and P 500 index. A P/E ratio measures the value of a company stock to it's current price per share earnings. In other words, it indicates the dollar amount you can expect to invest in a company in order to receive $1 of that company's earnings. Here's the P/E ratio formula. P/E ratio equals market value per share divided by the earnings per share. In general, a high P/E ratio suggests that you can expect higher earnings growth in the future compared to companies with lower P/E ratios. A low P/E ratio may indicate that the company is undervalued or that it's not doing very well relative to its past trends. When a company has no earnings or is posting losses, you'll see an NA where you would see a P/E ratio. Let's see an example of how this works company A's stocks price close at $91.09 cents company A's profits for the fiscal year ended in $13.64 billion company A's number of outstanding shares was 3.1 billion company A's EPS it's earnings per share is $4.40 cents. So you're taking 13.64 billion divide that by 3.1 billion. So company A's P/E ratio is $91.09 cents divided by $4.40 cents equals 20.7 times. This means that company A is currently trading at a P/E ratio multiple of around 20 times. You and other investors are willing to pay around $20 for $1 of current earnings. Now, the primary limitation to using a P/E ratio emerges when comparing P/E ratios of different companies. Valuations and growth rates of companies vary wildly between sectors. So it's important to only use the P/E ratio as a comparative tool when considering companies in the same sector. So compare the stock of one tech company to another tech company, not to the stock of a utility company. Now an expense ratio is a tool to review funds in the stock market. Where a fund consists of a group of company stocks in one portfolio. An expense ratio measures how much of a fund's assets are used for administrative and operating expenses. Remember because the fund consists of a group of stocks, someone has to manage which company stocks remain in the fund and which are taken out. This manager charges an expense to maintain the operation of that fund. So when looking at buying a fund pay attention to the expense ratio to determine if the fund is an appropriate investment for you after fees are considered. Here is the expense ratio formula. Expense ratio equals total fund costs divided by total fund assets. Operating expenses vary but it's good to know that the expenses within the fund remain relatively stable. For example, a fund with low operating expenses will continue to have low operating expenses. You won't see a sudden drastic increase in operating expenses. If the fund has a high cost of operating expenses this reduces the funds overall assets meaning that you will receive a smaller return on your investment.