Once you know the ratio, compare it for parallels with the other companies in the industries and for the market as a whole. Never forget, stocks with a very high p/e ratio can fall dramatically when even the littlest thing goes sour.
If you’re buying a finished item for resale, this is relatively easy. It’s trickier if you have to calculate all the factors, such as labour, that go into manufacturing a product. .
As an investor, it is important to see how the company uses their cash. You should be able to accomplish this by delving into the cash flow examples. You will be able to gain some insight into the management’s strategy and the future of the company. Is the company spending money on globalization or focusing on a new brand of product? A red flag should go up when you see the company borrowing too much because it could force them to use their cash to pay the interest rather than using it more productively.
Please note that this factor or rule of thumb could be much higher, depending on the number of years of income you will have to replace. The highest “factor” I’ve seen is to multiply your annual after-tax income by 20.