A stock is a price at which it is bought and sold. Stock prices fluctuate constantly, so it is difficult to know whether a stock is overpriced or underpriced. But some factors can help you make an educated guess.
How do you know if a stock is underpriced or overpriced?
Market efficiency is usually measured by the price-to-earnings ratio (P/E). This ratio reflects how much investors are willing to pay per dollar of earnings. If a company has a P/E of 50, then an investor would only be willing to pay $0.50 per dollar of profits the company makes.
If a company has a P/E of 25, then an investor would only be willing to pay $0.25 per dollar of earnings the company makes.
P/E Ratio Formula: Price per Earnings Ratio = Market P/E (Market P/E) / Earnings Per Share (EPS) The P/E Ratio tells you how much money the market is willing to pay for each dollar of earnings. For example, if a company’s current market P/E is 20 and its EPS is $2.00, it would sell for $40 per share.