Definition of Price-Earnings Ratio for Mutual Funds
The price-to-earnings (P/E) ratio is a valuation method used to value common stocks. The ratio is calculated as the price per share divided by the earnings per share. Either the estimated earnings for the next four quarters (forward P/E ratio), or the actual earnings for the previous four quarters (trailing P/E ratio), can be used in the denominator. The forward P/E ratio is generally considered a better predictor of future performance because it is based on what the market believes the earnings will be.
A mutual fund P/E Ratio is a combination of the P/E ratios of all the stocks held in a particular mutual fund. This can be calculated as a simple average with the P/E Ratio of each stock weighted equally, or each position weighted by the size relative to the total fund's assets.
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Sources of P/E Ratios
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Most mutual funds have a fact sheet or similar document on their website that lists the basic facts for that fund, including amount of assets, list of positions, and trading symbol. This data sometimes include the P/E ratio for the fund. Investors can also go to recognized statistical services like Morningstar or Yahoo to find P/E information. (See Resources for data on Fidelity's Magellan fund.)
High P/E Ratio Funds
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Investors should understand the implications of the level of the price-to-earnings ratio for a particular mutual fund. Funds that have a high P/E ratio are typically composed of stocks that have higher growth in earnings and sales, which is rewarded by the market with high multiples of price relative to earnings.
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Low P/E Ratio Funds
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Funds with a low P/E ratio are composed of stocks that have low growth expectations by investors. This may be due to the stock belonging to an industry that is in the trough of a business cycle, or may be related to company specific growth problems. Stocks with low P/E ratios are known as value stocks.
P/E Ratio Examples
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Here is a list of the average P/E ratios for several large mutual funds using Morningstar as the source (data as of June 30, 2009).
Fidelity Magellan -- 17.8
American Mutual Fund -- 13.1
Investment Company of America -- 13.3
American Century Ultra -- 15.9
Other Valuation Metrics
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Investors should not use the P/E Ratio exclusively to analyze a mutual fund. Other valuation data for analyzing a mutual fund include the average price-to-sales ratio and average price-to-book value for the fund. These valuation measures should be understood in the same context as the P/E ratio, with high levels indicating growth stocks and low values indicating value stocks.
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