Nearly 22 Million Americans are Millionaires

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There are nearly 22 million individuals in the U.S. with financial and real assets to fit the definition of being a millionaire, according to a 2021 Credit Suisse Global Wealth Report. Overall in 2020, total global wealth grew by 7.4% and wealth per adult rose by 6% to reach another record high of USD 79,952, according to the report.

Net worth, or “wealth,” is defined as the value of financial assets plus real assets (principally housing) owned by households, minus their debts.

The core reasons for asset price increases which have led to major gains in household wealth are a result of significant monetary and fiscal intervention by governments and central banks, like the U.S. Federal Reserve. Many governments and central banks in more advanced economies have taken pre-emptive action to prevent an economic recession in two primary ways: first, by organizing massive income transfer programs to support the individuals and businesses most adversely affected by the pandemic, and second, by lowering interest rates – often to levels close to zero – and making it clear that interest rates will stay low for some time.

There is little doubt that these interventions have been highly successful in meeting their immediate objectives of countering the economic impact of the pandemic. However, they have come at a cost. Public debt relative to GDP has risen in the U.S. and throughout the world by 20 percentage points or more, according to a 2021 Credit Suisse Global Wealth Report.

In essence, there has been a huge transfer from the government coffers to household net worth, which is one of the reasons why household wealth has been so resilient. In one respect, these transfers generously compensated households.

Generous payments have meant that disposable household income has been relatively stable and has even risen. In combination with restricted consumption opportunities, this has led to a surge in household saving, which has inflated household financial assets and caused household debts to be lower than they would be otherwise. This increase in savings was an important source of household wealth growth last year.

The lowering of interest rates by central banks has probably had the greatest impact on the growth in household wealth. It is a major reason why share prices and house prices have flourished, and these translate directly into our valuations of household wealth.

However, there are inflation implications in the long term from lowering the interest rates and also increased equity market volatility linked to expected future rises in interest rates. However, these were deemed relatively unimportant at the time compared to the more immediate economic challenges caused by the pandemic.

Household wealth appears to have simply continued to grow, paying little or no attention to the economic turmoil that should have hampered progress. Effectively, financial assets accounted for most of the gain in total household wealth accumulation.

The wealth of those with a higher share of equities among their assets, e.g. wealthier households in general. And, home owners in most markets, on the other hand, have seen capital gains due to rising house prices.

Wealth is a key component of the economic system. It is used as a store of resources for future consumption, particularly during retirement. Wealth also enhances opportunities when used either directly or as collateral for loans. But, most of all, wealth is valued for its capacity to reduce vulnerability to shocks such as unemployment, ill health, natural disasters or indeed a pandemic.

The contrast between those who have access to an emergency buffer and those who do not is evident at the best of times. Household wealth has played a crucial role in determining the resilience of both nations and individuals

Roughly 1% of adults in the world are USD millionaires.

Global household wealth may well have fallen. But aggressive governments and central banks to intervene help mitigate the economic impact of the pandemic. These have led to rapid share price and house price rises that have benefited those in the upper wealth echelons. In contrast, those in the lower wealth bands have tended to stand still, or, in many cases, regressed. The net result has been a marked rise in inequality

In many countries, the overall level of wealth remains below levels recorded before 2016. Some of the underlying factors may self-correct over time. For example, interest rates will begin to rise again at some point, and this will dampen asset prices.

References:

  1. https://www.cnbc.com/2021/12/22/heres-how-22-million-americans-became-millionaires.html
  2. https://www.credit-suisse.com/media/assets/corporate/docs/about-us/research/publications/global-wealth-report-2021-en.pdf
  3. https://www.credit-suisse.com/about-us/en/reports-research/global-wealth-report.html

Top Financial New Year’s Resolutions

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“Knowledge is power, and I submit that financial knowledge is also security.” Elizabeth Duke, Member of the Board of Governors of the Federal Reserve

It’s time for you to say goodbye to calendar year 2021 and to welcome in the New Year. And, it is time to think about setting financial resolutions and goals for the New Year.

You, like many Americans, should establish New Year’s financial resolutions that are both within your reach and represent your top financial priorities and aspirations.

The most popular financial goals are paying down debt, saving for emergencies, budgeting better and saving more for retirement, a Bankrate poll found.

The problem is that most people fail to keep their New Year’s resolutions.

“Everyone wants to make more money, save more money, invest more,” financial expert Steve Siebold, author of “How Money Works”, said. “But when it comes down to it, we tend to react emotionally instead of logically and that is the downfall.”

To help people you get started, here are a few resolutions that can help put you on track to achieve your financial objectives and dreams in 2022. 

Determining where you are financially

Before you can begin saving for the future, investing for the long term, spending less and building wealth, you must first figure out what are your current financial circumstances. It’s essential to determine your current cash flow (income minus expenses) and net worth (assets minus expenses). That’s the first critical step to making a comprehensive — and realistic — plan to achieve your financial goals and financial freedom. With regards to goals, You must get as specific and detailed as possible in defining your goals.

Once you determine where you’re financially, the subsequent step is to consider what you hope to accomplish financially in the next year or two. For instance, is buying a house at the top of the list? Maybe finally taking a vacation after nearly two years is a priority. One of your kids might be driving soon or preparing to leave for college. Reviewing what you need to save for is useful as you start to prep your financial blueprint. 

Pay down debt

Debt or loans are an excellent way to use future income to pay for an important purchase today, such as a car, an education, or a home. However, a Fidelity survey found that 41% of survey respondents expressed a strong desire to prioritize paying down debt or their loans in 2022. Additionally, a recent study found 75 percent of adults carry a credit card balance from month to month. Among those who carry a balance, the average amount is $5,315.

While there are many ways to use credit cards, personal loans and other forms of debt strategically to earn rewards, finance a big purchase and ultimately build your wealth, debt can still be a financial and emotional burden for many borrowers. Those with student loan debt, for example, often cite that their high monthly payments make it difficult for them to save for other goals, like owning a home.

One popular strategy for paying down debt is called the snowball method. It entails paying more toward your debt with the lowest balance while paying just the minimum on all your other debts. Once that debt is paid off, you can move onto the second lowest balance and repeat the process until you’re debt-free. This allows you to knock out one debt faster, which can make you feel accomplished and more motivated to keep tackling the others.

Create a financial plan

Having a financial plan or strategy will help you to achieve your financial goals and increase your likelihood of being financially healthy and achieving your financial goals in the long run.

Without a long term plan, you’re living in the moment which puts you at greater financial risk and leaves you with a more limited selection of financial options.

Financial planning is a process. It provides an overview of personal asset-building strategies that includes setting financial goals, budgeting, saving and investing, managing debt, and achieving financial freedom.

From the experience of many Americans, making a plan and sticking to it brings real success whether in the form of a healthier lifestyle or in the form of a more secure financial future.

Conversely, planning is essential for a more secure and healthy financial future.

Automate your savings

Saving is important, and you’re going to need to increase your savings to manage your financial lives successfully. American families rely on savings and investments to achieve a secure retirement, save for their children’s education, buy homes, start businesses, manage financial emergencies, and pass on wealth and opportunities to the next generation. This not only makes financial sense, but there’s a growing body of evidence that families with savings and assets generally do better in life.

Most people have the ability to save if they plan accordingly. One of the easiest ways to build savings is by automating contributions, which alleviates having to think about how much money to set aside each month.

Think about your own 401(k). At one point, perhaps when you were hired, you made one decision to save, and the rest was done for you–automatic payroll deductions, investments, statements, etc. Automatic payroll deductions can also be established to build general savings, savings for college, and other critical pre-retirement assets.

Regardless of which option you choose, make it a priority to have your savings automated.

Start an emergency fund

Nearly half of all Americans consider themselves financially fragile, meaning that they would “probably” (22.2 percent) or “certainly” (27.9 percent) be unable to come up with $2,000 in 30 days to cope with a financial emergency, according to a Brookings report. Similarly, almost half of all Americans report having trouble making ends meet.

Almost half of all households surveyed in the 2009 Survey of Consumer Finances had less than $3,000 in liquid savings, and 20 percent had less than $3,000 in broader savings. Finally, in a recent Bankrate survey on the effects of unemployment and the recession, 70 percent of workers reported withdrawing funds saved in college and retirement accounts for present day needs, likely leading to a significant loss of wealth in future years. But an emergency fund is an important financial tool that can help deal with unexpected expenses, such as home or car repairs.

These circumstances emphasize the importance of savings that can be used for emergencies. Even a minimum amount of emergency savings can have a significant impact, especially among lower-income households. In fact, the Consumer Federation of America found that low-income families with $500 in emergency savings had better financial outcomes than moderate-income families with lower savings.

The new year is as good a time as any to start (or grow) your emergency fund. In general, experts recommend saving three to six months of living expenses. Start by opening a separate and dedicated high-yield savings account.

Boost your retirement savings

Saving for retirement is one of the most important aspects of a sound financial plan.

“Use [the new year] to boost or maximize contributions to 401(k)s or HSAs, plot out holistic retirement goals (e.g., Where will I live? Will I work? How much to budget for travel?) and, no matter your age or life stage, take meaningful steps to boost your financial wellness,” says Lorna Sabbia, head of retirement and personal wealth solutions at Bank of America.

There are a few ways you can boost your retirement savings. For one, if your employer offers a 401(k) match, be sure you’re contributing enough to get the full match since it’s essentially free money. Another thing to consider is looking at where your money is being invested. Many experts recommend investing in a diverse portfolio of assets to reduce your risk but still achieve attractive returns.

Finally, it’s important to remember that the only way you get the market’s long-term average return of 10 percent is by holding through all the tough times.

“Your retirement savings will grow quicker if you pick a solid long-term plan and then stick with it through the good and bad times, but especially the bad times,” says James Royal, Bankrate investment and wealth management reporter.

Royal says that investors should continue adding to the account and keep from selling, no matter how tempting it may be.

Invest more

Don’t limit your investing to only making tax-advantaged retirement contributions.

If you already have an emergency savings account, consider setting up an investment account for goals with specific time horizons, like early retirement or saving for a house.

“While it’s great to max out your tax-advantaged retirement accounts — $6,000 in an IRA and up to $20,500 in a 401(k) — you’re going to have even more opportunities if you save in a taxable account as well,” Royal says.

Royal adds that some of the biggest perks of investing outside of your retirement account include:

  • No limit to what you can save.
  • Tax deferral benefits on unrealized gains (stocks you don’t sell).
  • Immediate access to the cash without penalties or other restrictions.

If you’re just getting started, consider looking into a robo-advisor, which will do the investing for you after taking your risk tolerance and ideal earnings into consideration.

As we head into the new year, saving more money, spending less and paying down debt are all top-of-mind for many Americans. There are many ways to achieve these goals, but the most important step is considering what’s right for your personal circumstances. This will help set you up for success when working toward those goals.

Focus on physical health

Nearly everyone wants to lose weight after the holidays. However, health professionals contend that it’s not about shedding pounds, but managing your physical health that’s the most important.

Rather than focusing on losing weight, focus your energies on making a lifestyle change like resolving to eat something healthy every day. Or, if your gym routine has dried up, try new exercises to pique your interest.

There s a strong correlation and relationship between eating healthy and physical health to financial health. Aside from making sure your finances are in order, experts also recommended taking care of your physical health through exercise, nutritional diet and other healthy practices. 

By doing those things, you could decrease your health care costs and make wiser financial decisions focused more on the long term. 

Focus on increasing your net worth

A successful financial life isn’t about increasing your annual income — it’s about increasing your net worth, which is assets minus liabilities.

“Focus on your net worth before focusing on your income,” said Chris Peach, founder of Money Peach. “No one ever talks about how much Bill Gates, Jeff Bezos or Oprah Winfrey makes — they report their net worth. The reason is the true measure of wealth is not your income, but rather your net worth. Once you have your net worth on paper, set a goal to increase your net worth. To do so, identify ways you can decrease the amount you owe and how you can add to what you own.

And if any of this seems daunting, remember that one of the best ways to achieve a big goal is to break it down into smaller pieces. “Start with the end in mind,” said Peach. “Determine where you will be one year from now and then reverse engineer your goal to determine what it actually looks like.”

Almost everyone has that one big dream or big audacious goal they have filed away in the “someday” category of their brains. Make 2022 the year that you resolve to start accomplishing that goal.

References:

  1. https://www.bankrate.com/banking/top-financial-new-years-resolutions/
  2. https://www.cnbc.com/2022/01/01/how-to-keep-your-financial-new-years-resolutions.html
  3. https://www.cnbc.com/select/2022-financial-new-years-resolutions-americans/
  4. https://www.federalreserve.gov/newsevents/speech/duke20111022a.htm
  5. https://www.msn.com/en-us/news/technology/5-new-years-financial-resolutions-you-can-keep/ar-AASeI4p
  6. Annamaria Lusardi, Daniel Schneider, and Peter Tufano (2011), “Financially Fragile Households: Evidence and Implications (PDF), Brookings Papers on Economic Activity (Washington, D.C.: Brookings Institution , Spring)
  7. https://www.gobankingrates.com/money/financial-planning/9-new-years-resolutions-successful-people-make-year

Positive and Optimistic Mindset for Healthy Aging

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It’s essential to look ahead with optimism and a positive outlook as you age.

With advance aging, you should adopt an optimistic and positive mind-set and focus on new discoveries and experiences. It’s more important than ever as you age to follow a healthy lifestyle, remain positive and passionate about life, stay connected with family and friends, and look forward to better days ahead.

You must consistently attempt to find things that continue to be meaningful and engaging. These meaningful activities can include traveling around the world, spiritual pursuits, hobbies such as reading or painting, lifelong learning, or spending more time with loved ones. Experts suggest planning for purposeful activities before transitioning to retirement, and to embrace this change and follow where their passions lie.

Try to keep the mind active by challenging yourself to learn something new every week or month, or try something you’ve always wanted to.

Embrace thoughts such as, “As I age, I’ll keep learning,” says Vonetta Dotson, an associate professor of psychology and gerontology at Georgia State University. Feeding yourself a rich diet of positive messages can in itself brighten your outlook.

“Anytime we do something and try new things, it helps to reinforce this feeling of positivity,” Dotson said. “And keep those social connections. When you socialize, your focus is diverted. When you’re by yourself, you may ruminate” about your current and future physical and mental deterioration.”

Better yet, learning something new enables your brain to form new pathways. This helps you stave off gloomy thoughts about the aging process.

“By engaging in rewarding and meaningful activities and staying mentally active, we can retrain our brains,” said Kevin Manning, a neuropsychologist and associate professor of psychiatry at UConn Health. “These activities can enhance our self-efficacy, lessen fears of decline and sharpen our cognitive functioning.”

Ideally, passion drives you to take action. Why sign up for a course on current events or foreign affairs if you find the state of the world dispiriting and you dread consuming the news?

To channel your activity in a more uplifting direction, set short-term goals. If you’re learning a musical instrument, aim to perform a simple piece in one month.

When you embrace a purpose that gives you something to do that’s meaningful,” it focuses your efforts and displaces fears of aging. It’s one of several keys to healthy aging.

The key to healthy aging is a physically, socially, mentally and spiritually active lifestyle and mindset.

References:

  1. https://www.barrons.com/articles/depression-aging-retirement-51640306803
  2. https://vailhealthfoundation.org/news/10-tips-for-healthy-aging-month-2021/
  3. https://healthprep.com/aging/secrets-to-aging-gracefully/

Believe in Yourself and in Your Goals

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“We are what we repeatedly do.” Aristotle

Belief in Yourself and in Your Goals are an essential first step and ingredient for living the life you dream. You must believe in yourself and have faith in your abilities if you ever expect to succeed and prosper.

The adage — Winners expect to win and successful people expect to succeed — remains true today as it has over the past several decades.

A shortage of belief causes many people to give up steps short of their intended destination or to never begin in the first place. In many cases, it causes one to quit and sabotage their success when right on the doorstep.

Many people simply don’t feel worthy of success. It’s based on an erroneous belief or mindset implanted when young and allowed to grow unchallenged. Nevertheless, it’s essential that you have find that belief in yourself and faith in your abilities in order to have the life you desire and deserve.

You deserve to be successful. There is no reason for you not to have what you want unless you ignore the principles of success, fail to take the first step and quit before reaching your destination.

Set goals that are specific and challenging (but not too hard).

When people followed two principles — setting specific and challenging goals — it led to higher performance and achievement 90 percent of the time. Basically, the more specific and challenging your goals, the higher your motivation toward hitting them.

When you have that much clarity around your goal, your chances of hitting the mark increase dramatically.

Be passionate about your goals and committed to the end.

Research says that successful people achieve their goals not simply because of who they are, but more often because of what they do.

Use a feedback cycle to track progress.

Align all your goals.

Psychologists have found that people who are mentally healthy and happy have a higher degree of ‘vertical coherence’ among their goals — that is, higher-level (long-term) goals and lower-level (immediate) goals all fit together well so that pursuing one’s short-term goals advances the pursuit of long-term goals.

Lean on trusted advisors.

Seeking out expert guidance and advice makes a big impact on achieving your goals. That’s why successful people are no lone rangers. They surround themselves with mentors and advisors who will support them on their journey.

Avoid multitasking

The most successful people are very patient and live by the motto “one step at a time.” They also avoid juggling many things. Multitasking is not a good strategy for success according to research. Multitasking splits your focus over many tasks, causing you to lose focus, lowering the quality of your work and taking longer to hit your goals.

work on several smaller chunks to complete a big goal. But they do it by knocking one down then moving on to the next one.

As you break the goal down into smaller chunks, each of those chunks should have their own deadlines. Amy Morin in Forbes calls these “now deadlines”

“….break the goal down into smaller chunks, each of those chunks should have their own deadlines.”

References:

  1. https://www.inc.com/marcel-schwantes/science-says-92-percent-of-people-dont-achieve-goals-heres-how-the-other-8-perce.html
  2. http://successnet.org/cms/goals/top-ten-reasons-people-dont-achieve-their-goals

Tips for New Investors

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Getting started can be the biggest hurdle for new investors.

To get started, it’s important for new investors to set clear investment objectives, open a brokerage account, create a plan, and start investing with a long-term view. You’ll gain knowledge over time. While your investment strategy may change, getting started sooner rather than later is a good first step.

Additionally, every new investor should first make an honest assessment of where they are in life and their financial priorities. And they should leave emotion out of it. And, begin investing early in life so your money will have plenty of time to grow. A 10-year difference can have a significant effect on compounding returns.

https://fb.watch/9iNk-bRTiD/

Putting together a successful investment portfolio takes a combination of research, an investing plan, patience, and a little bit of risk.

For instance, there is plenty of research showing that frequently buying and selling stocks often leads to significantly lower long term returns than buying and holding. According to the investment research, investors who try to time the market more often get lower returns, but they also introduce more volatility into their portfolio.

By paying a lower price for an investment relative to its earnings or intrinsic value, one would expect a higher income yield in the near term, as well as the greater appreciation over the long term to the extent that free cash flow, earnings and net income increases in the future (of course, all investments involve risk and there can be no guarantees of any returns).

References:

  1. https://www.thebalance.com/the-6-dumbest-things-new-stock-investors-do-357191
  2. https://www.thebalance.com/things-investors-should-know-357631

Persistence and Perseverance

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“Nothing in the world can take the place of persistence.

Talent will not; nothing is more common than unsuccessful men with talent.

Genius will not; unrewarded genius is almost a proverb.

Education will not; the world is full of educated derelicts.

Persistence and determination alone are omnipotent.

The slogan “press on” has solved and always will solve the problems of the human race.”

Calvin Coolidge

“Three simple rules in life and habits…Go, Ask, and Do:

  1. If you do not go after what you want, you’ll never have it.

  2. If you do not ask, the answer will always be no.

  3. If you do not step forward, you will always be in the same place.”

Austin Miller, VP of Talent Management at Sorenson Capital Partners

Inflation: The Elephant in the Room

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November’s CPI report showed consumer prices rising at rates last seen four decades ago.

Inflation is the biggest risk facing the equity market and is likely to end the record long bull-market. Inflation has a long history of eroding the value of financial assets and brings with it higher interest rates as central bankers try to tamp it down.

The annual inflation rate accelerated significantly in 2021, from about 0.5% at the start of the year to over 3% by September. This was driven by increased demand as the economy reopened and by a sharp rise in energy prices, among other factors.

In October, inflation measured by the consumer price index was up 6.2% from a year earlier, the highest annual rate since November 1990. It marked the sixth straight month above 5%. Kiplinger expects inflation to hit 6.6% by year-end 2021 before falling back to 2.8% by the end of 2022 – above the 2% average rate of the past decade.

“Inflation is in the air, and it risks becoming a market issue, an economic issue and a political issue,” says Katie Nixon, chief investment officer at Northern Trust Wealth Management.

As we enter 2022, inflation is expected to remain a risk amid higher food and gas prices, rising pressures from non-energy industrial sectors such as steel and chemicals, higher food and consumer goods prices, and increases in the energy prices.

Economists expect headline CPI to peak between 4.5% and 5% in the first half of 2022 and approach 2.5% year over year by the end of 2022.

References;

  1. https://www.kiplinger.com/investing/stocks/stocks-to-buy/603814/where-to-invest-in-2022
  2. https://investor.vanguard.com/investor-resources-education/article/simple-strategies-for-reducing-inflation-risk

Peace and Joy Be With You in Abundance

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Share the Peace and Joy of Christmas

Peace is an inner state of well-being and calm. Peace is more than the absence of war and conflict. Peace means wholeness, peace of mind, quietness, or rest. Peace is being well, whole and complete. It means to be in the midst of noise, trouble, turmoil or hard work, and still be calm in your heart and mind. Peace comes when your mind, body and spirit are in harmony. It is the favor blessings from God over our lives.

Joy is a feeling of great happiness; an extreme sense of gladness and delight. A sense of contentment of where we are. It’s an emotion evoked by well-being, success, good fortune or by the prospect of possessing what one desires. Joy is the presence of hope, meaning and purpose in our lives. Spiritual Joy – can be only found in a relationship with God. And, it does not change with the circumstances of life. When Jesus was born, he brought joy into the world along with righteousness and peace. Spiritual joy is a deep cheerfulness and gladness of heart. It is happiness and a calm spirit.

Family. Friends. Peace. Joy.

Wishing you and family the best this Christmas holiday season.

And May Peace and Joy Be With You in Abundance!

References:

  1. https://wau.org/resources/article/peace_be_with_you/

Financial Literacy Education

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Financial literacy, quite simply, is a prerequisite for financial freedom. Financial Times

Fixing economic, income and wealth inequality across the nation and globe remains a Herculean task. But, by emphasizing basic financial literacy education — to boost budgeting skills, debt knowhow and investment knowledge— need not be. And basic financial understanding can make a vast difference — not just to economically disadvantage communities, but to anyone in virtually any circumstance.

The correlation between high levels of economic and financial inequality and low levels of financial literacy and understanding is one of the starkest. The problems are worsened by low levels of knowledge about how debt interest is calculated, how it compounds and how to mitigate risk or budget effectively.

From the 2014 S&P Global FinLit Survey, only a third of the world’s population were deemed financially literate, according to analysis by the World Bank.

Financial literacy education, done right, can be a source of emancipation for the economically disadvantaged seeking a way out of deprivation.

Targeted at the young, in particular, it can lay down vital foundations for future prosperity and teaching them about risk and investment opportunity. One of the big reasons to target young people is that later in life they become much harder to reach.

Too many children think money grows on trees. They don’t realise that they have to budget all this money as they get older, they’ve got to pay these bills. FinLit should be one of the things that’s taught to prepare the young for the real world.

“Narrowing the financial literacy gap is crucial for narrowing the wealth gap. But financial literacy clearly needs a boost across the social strata too”, says Aimée Allam, executive director of FT FLIC.

The best investment you can make is in yourself and in your financial education. It’s the obvious starting point to building wealth and achieving financial freedom. And, here are seven reasons:

  • Provides dividends for life that nobody can ever take from you.
  • Increases your earning potential.
  • Increases your return on investment.
  • Improves the quality of your life and finances.
  • Secures your retirement.
  • Defends your portfolio from unnecessary losses.
  • Provides peace of mind around money.

To ensure you become financially free, take the income you think you’ll need in retirement and multiply it by 20. That’s what you need to put away in order to live off the interest without touching your principle.

Determine how much risk tolerance you have as you look to compound the money you’ve set aside for retirement. the billionaire’s secret, whereby they get Risk/Growth-like returns with assets that would fall in the Security asset class. The wealthy risk very little and expect substantial returns.

References:

  1. https://www.ft.com/content/80480742-9853-4144-9c91-238021414bc8
  2. https://financialmentor.com/financial-advice/financial-education-best-investment/13173

Valuing a Company | Motley Fool

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The most common way to value a stock is to compute the company’s price-to-earnings (P/E) ratio. The P/E ratio equals the company’s stock price divided by its most recently reported earnings per share (EPS).

You can calculate it two different ways, by:

  • Taking the company’s market cap and dividing it by net income – or,
  • Dividing a company’s current stock price by earnings per share

You’ll wind up with the same number either way because in the share price approach, both numbers have already been divided by the total number of shares the company has outstanding. So it’s two different ways to the same place.

A low P/E ratio implies that an investor buying the stock is receiving an attractive amount of value.

You’ll usually see the P/E ratio quoted two different ways:

  • Trailing twelve month (TTM) – which looks at the company’s actual income over the past twelve months.
  • Forward – This approach takes analyst estimates of earnings expectations for the upcoming year and using that as the earnings figure.

If a company is growing, its forward P/E ratio will always be smaller than its trailing twelve month P/E ratio, because more income is expected and the denominator will be larger. If you see a P/E ratio out in the wild and it isn’t specified which kind it is, you can probably assume it’s based on the company’s trailing twelve month earnings.

The P/E ratio only works if there’s an E – or earnings. So it’s a helpful tool for companies that have income, but it’s totally useless if a company isn’t currently profitable. That’s why investors also use another tool for unprofitable companies, the P/E ratio would return a negative number, which really wouldn’t be very helpful, so instead investors use the price to sales ratio.

Price-to-sales is a company’s market cap divided by its total sales over the past twelve months. Because the P/S ratio is based on revenue instead of earnings, this metric is widely used to evaluate public companies that do not have earnings because they are not yet profitable.

High growth software companies can have price-to-sales ratios of over 10, while more established businesses are usually in the mid to low single digits. The P/E and P/S ratios are great because they allow you to normalize companies of different sizes and immediately get a sense of what investors are willing to pay for a piece of that company’s earnings or revenue.

You can use these ratios to compare how a company stacks up to the overall stock market, peers in their industry, or itself relative to the past. Generally, businesses that are posting high growth rates are going to have higher price-to-earnings and price-to-sales ratios. That’s because investors expect that company to be considerably bigger in the future, and they have bid up shares to reflect that. That doesn’t mean that they’re bad stocks to own, it just means that people are expecting big growth to continue and if it doesn’t, shares could fall dramatically.

Conversely, stodgy old businesses in crawling industries tend to have lower p/e ratios because they aren’t growing very quickly – for them this year’s earnings will probably look a lot like last year’s earnings. The market isn’t expecting much from stocks with low valuations, so if the outlook gets worse, they’re less likely to take a huge hit, but they’re also less likely to give investors huge returns.

All you’re trying to do with valuation is to get a sense of how much you have to pay for a dollar of earnings or revenue from a company, and what the market expects of that company.

You can look at to see how a company’s valuation compares to the growth the company is posting. The PEG ratio accounts for the rate at which a company’s earnings are growing. It is calculated by dividing the company’s P/E ratio by its expected rate of earnings growth.

Most investors use a company’s projected rate of growth over the upcoming five years, you can use a projected growth rate for any duration of time. Using growth rate projections for shorter periods of time increases the reliability of the resulting PEG ratio.

The generally accepted rule is that a PEG ratio of 1 represents a “fair value” while anything under 1 is cheap and anything over 1 is expensive compared to the growth the company is posted.

For all these ratios there aren’t absolutes, just guidelines.

As investors we’re looking for quality companies with good business models and exciting growth prospects — it’s worth paying a premium for companies like that, these metrics help us understand what the premium looks like and how it fits into the company’s growth story.

References:

  1. https://www.fool.com/investing/how-to-invest/stocks/how-to-value-stock/