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Reader: Please help me to understand how P/E ratios are established. If a company earns X in a given year, how does the market determine the company's future earnings potential? And, if a company reports somewhat disappointing earnings in a given quarter, how are the adjustments to potential growth calculated? --P.D.

Gregg Greenberg: Your first question is the easiest to answer because it's just a matter of simple math. After that, things, as they tend to do on Wall Street, get a bit fuzzy.

A company's P/E, or "price-to-earnings" ratio, is established by dividing the current share price by the annual earnings per share. Some investors prefer to use the "12-month trailing" earnings in the denominator, because that's actual earnings, while others prefer using "forward" earnings estimates.

It's in the use of forward earnings estimates where things start to get hairy.

Forward estimates are educated guesses made by Wall Street analysts as to a company's earnings per share for an upcoming quarter or fiscal year. The analysts' guesses can be considered "educated" because they are often guided by the companies themselves. Each Wall Street analyst creates his or her own set of forward estimates, then a service like Thomson First Call takes the average of the expectations.

Finally, on D-day, when a company reports its actual earnings for the quarter, both the analysts and the company are put to the test. If the company's profits fail to match or beat the average earnings estimate, the stock usually gets creamed. That's called a "negative surprise." If a company "beats" estimates it's called an "upside surprise" and the stock more often than not heads higher.

(If a particular analyst is way off in his estimate, and continues to be wrong quarter after quarter, then you may want to look for another analyst, and he may want to look for another job.)

Now that we have that straight, let's move to the second part of your question, concerning growth rates.

Once the company announces its actual earnings, analysts can determine the company's earnings growth rate by comparing this year's quarterly results against last year's. The actual percentage change in earnings per share is the company's earnings growth rate.

Then, of course, things get slightly hairy again, because Wall Street likes to look forward to where a stock is going, not backward to where it has been.

In order to make forward estimates for the next quarter, the analysts need to guess how much the company will increase, or shrink, its earnings. To find the future earnings growth rate, the Wall Street community compares this year's quarterly results -- not against last year's actual results -- but against their own forward estimates.

And then the whole wacky process starts again.

Reader: What do you think of buying a good high-rated stock by averaging down? Charges are not a problem since I like to buy and hold. Thanks! --D.H.

GG: Averaging down, or buying additional shares of a stock you already own at a lower price, can be a great idea. You buy more shares when the price is lower, and it lessens the risk of investing a large amount in a single investment at the wrong time.

However, there is a potential pitfall associated with this strategy, and I believe that it's my duty to warn you about it before it's too late.

So listen up: Don't fall in love with a stock! And if you find yourself falling in love with a stock ... snap out of it! Just like in life, loving a stock too much can blind you to problems you may have otherwise seen.

Every company goes through tough times that can cause its stock price to swoon. Sometimes it's the company's fault, sometimes it's not. Higher-than-expected energy costs, labor problems, a competitor gets lucky ... these things happen even to the best companies. And when they do, you may get an opportunity to buy stock at a cheaper price than you ever have before.

If you believe the fundamentals are still there, then averaging down can be a huge benefit. There is no reason not to take advantage of a sale.

But if you find yourself continually buying shares at lower and lower prices, you may want to dig a little deeper to find out why the market is not as keen on your beloved company as you are.

Maybe the market, which supposedly represents the collective wisdom of all investors, is seeing a problem you aren't. Or maybe you are so intent on lowering your cost basis that you refuse to see any real competition on the horizon.

The hazard is that one day you wake up and realize that your favorite company has real problems. And while you were busy tuning out the bad news -- and buying more shares in the process -- your portfolio has grown out of whack and overridden by a truly troubled company.

Remember that love can not only break your heart, it can also break your bank account if you let it. So don't.

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