Price-to-earnings. A price-to-earnings ratio, which essentially weighs what you pay for a company against what it's earning, has historically been the most popular way to judge a company based on one number. But P/E's don't tell the whole story. (A good rule of thumb is never to consider any one figure or ratio alone.) "The problem is that your e is not always representative of how much you're making because it can be manipulated by accounting," says Hanson. For example, a company may have shipped products and recorded them as assets under "accounts receivable," even though those products haven't yet sold. Try this simple detective procedure from Hanson: "Make sure the net earnings they're reporting actually match their cash earnings. If they don't match, a lot of the time it's accounts receivable."
Investors often use P/Es to compare companies and spot bargains. It's important to keep in mind that P/E ranges sometimes differ from industry to industry in accordance with that industry's growth expectations. Technology stocks typically have higher P/Es than utilities, for example. Be sure to compare companies with peers in their industry, and take into account the industry's overall growth prospects.
Another tip: Auer suggests looking at a company's earnings over the past three years—as opposed to the past few quarters—to get a better picture of its profitability. "Three years takes out the troughs," he says. "And if you're looking for a safety net, see if they were profitable in 2008."
lingsd of AZ @ Jun 13, 2009 11:17:12 AM