Professional stock-pickers look for a healthy company and buy when they believe the price is right. For example, two companies might be projected to earn $5 per share in 2002, with future earnings growth at 15 percent per year. If one company’s stock trades at $50 per share and the other company at $100 a share, the former is the better value.
One key to stock market analysis is a company’s price-to-earnings (P/E) ratio. In the above example, with two companies earning $5 per share, the company trading at $50 has a P/E of 10 while the company trading at $100 has a P/E of 20. Generally, value investors prefer relatively low P/E ratios.
Analysts who focus on fundamentals often use the acronym GARP, for growth-at-a-reasonable-price, to describe the stocks they prefer to buy. That is, they compare a company’s rate of earnings growth with its P/E ratio. Here, the company trading at $50 has a P/E of 10 while the company trading at $100 has a P/E of 20. Compared with an earnings growth rate of 15 percent, the former may offer GARP while the latter may seem pricey.