Chapter 3: A Century of Stock Market History (The Intelligent Investor)

It is important to learn about the history of the stock market, so that you understand how stock prices are related to earnings, cash flow, and dividends.

The price of a stock changes, according to real growth (company’s earnings and dividends), inflationary growth, and the amount of speculation (up or down).

The PE 10 ratio, developed by Nobel Laurate Shiller, compares current S&P 500 index prices to an inflation adjusted average of profits over the past 10 years.

The P/E ratio helps investors determine the market value of a stock as compared to the company’s earnings. In short, the P/E ratio shows what the market is willing to pay today for a stock based on its past or future earnings. A high P/E could mean that a stock’s price is high relative to earnings and possibly overvalued. Conversely, a low P/E might indicate that the current stock price is low relative to earnings.Source

While the P/E ratio could be useful, it is a metric that varies widely between different sectors. It should only be used to compare companies within the same sector, and even then it should be used with caution, since the source of information about earnings come from the companies themselves, and could be inaccurate.

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Related posts:

1. Chapter 2: The Investor and Inflation (The Intelligent Investor)
2. Chapter 1: Investment Versus Speculation (The Intelligent Investor)
3. The Stock Market (Against the Gods)
4. Chapter 8: In the long view of history, moral codes are universal and necessary (The Lessons of History)