Financial Reference

It’s so easy to figure out the cheapness of a stock. All you have to do calculate the P/E ratio by dividing the price of the stock by the earnings per share. Right? If only it was that easy…

Even though many well-regarded newspapers mainly limit themselves to the P/E ratio and the projected growth rate.

Many stories read like this, “HP trades at a forward P/E multiple in line with IBM and several points cheaper than Dell. This is a bargain of a growth technology company with the Price-Earnings-Growth ratio now under 1.”

In other words, all you have to do is compare P/E ratios — either current or forward (projected one year forward) — and you can figure out what is cheaper.

The problem with the raw P/E ratio is that it is overly simplistic. For example, the $14 billion in cash on Dell’s balance sheet is not accounted for in the ratio. If we account for the cash on the balance sheet, by taking out the interest income from income and the cash from the market cap, the adjusted P/E will show a much more accurate picture.

While this calculation is only the beginning of the analysis, it is an easy adjustment to make and can make a huge difference in the analysis.

(Disclosure: I own Dell but do not own any of the other securities mentioned)