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The Wise Investor

is the 'price-earnings ratio', often written as the PE or P/E
ratio. You will remember, Kate, when I talked earlier about
the yield on investments. A 100-dollar investment with an
income of 14 dollars per year has a 14 percent yield.
When we are speaking about shares, the yield is often
expressed in a different way. The 'price-earnings' ratio is the
price of the shares divided by the earnings of the company.
For example, a PE ratio of twenty means that the share
price is equal to twenty times the earnings.
If a PE ratio is turned upside-down by dividing it into one,
it becomes the “earnings yield”. This figure can be directly
compared with the yield on other investments.
For example, a PE ratio of 20 is equivalent to an earnings
yield of 5%. This is a very important statistic.
As I spoke about previously, every investment should be
considered on its merits, and the yield that an investment
generates is one of the most important factors. If a share
generates a lower yield than other shares and other
investments, it may have trouble maintaining its share price
and there is a risk of a decline in the price.
Another important figure is the 'dividend yield'. This is the
dividends that the company distributes, as a percentage of
the cost of the shares. A dividend yield of 4 percent means
that you will receive the same income from the share as you
would from a bank deposit at 4 percent interest.
However, a low dividend yield is not necessarily a bad
thing, as the company may be retaining much of its profits to
expand the business and increase the value of the shares.
Look at the PE ratio, also expressed as the earnings
yield, to determine if the share is over priced. Also look for a
high dividend yield if a high income is important to you.
Finally, read everything you can about the company, to
get an impression of the quality of the company. In the long
term, this is more important than the current figures.
Remember, too, that the figures are generally based on
previous profits and dividends, but what matters is the
future."
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