Understanding Price-to-Earnings Ratios

Have you ever bought a pair of pants for your child or grandchild that were too big? It’s a common occurrence, and when it happens, you have two options: 1) you can throw the pants in the wash and try to shrink them, or 2) you can just sit back knowing that your child or grandchild will eventually grow into them. This same phenomenon applies when the price of stocks gets overinflated in relation to annual corporate profits. If you can learn to recognize when it’s happening, that knowledge can go a long way toward helping you make smart savings and investment decisions.