If good companies made good investments, investment decisions would be a cake walk, just pick up the best companies like google, amazon, facebook and invest your money in their stocks, and wait for your money grow. The problem is everyone knows that and this high expectation is reflected in their high share price in relation to its earnings. And if the stock is overpriced, investors can make negative returns. A good example is share price of Amazon, if you have purchased amazon.com shares 2000 you would have made huge losses, you would have to wait nearly a decade just to break even. Click here to see the historical price chart of Amazon at Yahoo Finance.
How to make a rough estimate if the share price is high:
P/E is market price per share divided by annual earning per share. For example, if a company’s current share price is ₹100 per share and annual earnings per share is ₹5. Then the P/E is 100/5 which is 20. Interpretation of a range of values of P/E is available at wikipedia . A P/E value of 17 or over indicates the company’s share a trading a high price.
P/E is market price per share divided by book value per share. Book value is companies asset minus liabilities. P/B may not give accurate picture for certain industries.
Shiller P/E or PE10 or CAPE
P/E is market price per share divided by E10. E10 is the average of the inflation adjusted annual earning. An example calculation on how to calculate Shiller P/E is available at Nasdaq.com. Shiller PE is good at estimating overall market may or may be give a accurate picture of individual stocks.
None of these methods are pe