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How to Use a P/E Ratio When Picking Stocks

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What is a good price-to-earnings ratio? 

Well, let's go over what that is and how it's calculated first. 

Take a company's expected earnings for the next year. Then take the market capitalization (the market equity value of the company). Divide the market cap by the expected forward one year earnings number. That gives you the price-to-earnings ratio, or the earnings multiple. 

You'll notice it'll be quite a multiple. A low P/E ratio, for example, would be 10. So how does a company have $100 of expected earnings and a market value of $1,000? It's based on future cash flows for the next 6 to 10 years. 

If you still have questions, don't worry, we break it down even further in our 60 Seconds (or so) specialseries above.

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