Price To Earnings Ratio,P/E Ratio

The P/E ratio (price-to-earnings ratio) of a stock (also called its “P/E”, or simply “multiple”) is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share.[2] It is a financial ratio used for valuation: a higher P/E ratio means that investors are paying more for each unit of net income, so the stock is more expensive compared to one with lower P/E ratio. The P/E ratio has units of years,[note 1] which can be interpreted as “number of years of earnings to pay back purchase price”, ignoring the time value of money. In other words, P/E ratio shows current investor demand for a company share. The reciprocal of the PE ratio is known as the earnings yield. The earnings yield is an estimate of expected return to be earned from holding the stock if we accept certain restrictive assumptions

How To Find P/E And PEG Ratios

When reading about or researching company performance, you often will be reflecting on earnings calculations – but do these numbers make any sense to you? And could you tell the difference between a P/E ratio and a PEG ratio?

Tutorial: The P/E Ratio

The stock price (per share) of a company divided by its most recent 12-month earnings per share is called its price-to-earnings ratio (P/E ratio). If this P/E ratio is then divided by expected earnings growth going forward, the result is called the price/earnings to growth ratio (PEG ratio). A lot of the information out there about how to determine a stock’s proper ratios and use them to effectively value a stock discuss metrics like the stock’s historic ratios, using them to compare industry ratios, or make statements like “a PEG below 1 is good”.

This information isn’t wrong, but if you need to understand and find these ratios for yourself, you’ll need some extra help. Fortunately, with the aid of a simple hand-held financial calculator, there is a simple mathematical approach to finding rational P/E and PEG ratios.

Understanding Price to Earnings Ratio

P/E = Stock Price / EPS

For example, a company with a share price of $40 and an EPS of 8 would have a P/E of 5 ($40 / 8 = 5).

What does P/E tell you? The P/E gives you an idea of what the market is willing to pay for the company’s earnings. The higher the P/E the more the market is willing to pay for the company’s earnings. Some investors read a high P/E as an overpriced stock and that may be the case, however it can also indicate the market has high hopes for this stock’s future and has bid up the price.

Conversely, a low P/E may indicate a “vote of no confidence” by the market or it could mean this is a sleeper that the market has overlooked. Known as value stocks, many investors made their fortunes spotting these “diamonds in the rough” before the rest of the market discovered their true worth.