Look at P/E Trend When Considering Growth Prospects

"Microsoft's stock has been treading water for years". I've heard that more than a few times. Basically MSFT has traded between $30 and $24 for a couple years. But that doesn't really mean that the price of Microsoft has not changed for years. As I discussed before, the true price investors are willing to pay for a stock is the Price/Earnings ratio. This consideration applies to any stock, of course, I'm just using Microsoft as an example.

Microsoft's stock price has hardly changed in the past year, yet their earnings have continually grown. Thus the P/E ratio has been decreasing:


Observing those plots, you see that as earnings have grown, the price investors have been willing to pay per dollar of earnings (P/E) has decreased, resulting in what looks like a stock price treading water. [I generated this chart at www.BigCharts.com, under interactive charting].

This is important, because you might buy Microsoft based on the fact that there are still growth prospects; they are still growing earnings. But unfortunately the trend has been to pay less and less for their earnings. Thus there is a chance that the stock price will continue to 'tread water', and never reflect the earnings growth. I hope it's not true in this case, as I own Microsoft stock. But my point is that it's important to look at the P/E trend along with the earnings trend and price / share trend, when considering a stock purchase.