PE Ratio

Financial Dictionary -> Investing -> PE Ratio

The P/E ratio or Price to Earnings ratio is a measure of a company's current share price compared to its annual earnings per share. It is one of the oldest and most commonly used ratios on the stock market. To calculate the ratio:

P/E = Market Value per Share / Earnings per Share

So for example if a company's market value per share was $40 and its earnings over the last year were $2 per share, the P/E ratio for the stock would be 20, because $40 divided by $2 is 20.

This ratio can be used by taking data from the last 4 quarters, in other words the last year, or the ratio can be used as an estimate, buy estimating earnings in the next four quarters and using those as the input figures. However the P/E ratio is only as good as the numbers input, so data must be accurate and unbiased.

The P/E ratio is used by investors to whether a company is high or low. Usually, a high P/E ratio suggests that investors expect increase in earnings in the future compared to companies with a lower P/E ratio. However it is only useful when comparing two companies in the same industry as there are industry specific factors involved ad growth prospects.

Companies that have high Price to Earnings ratios are expected to be more risky investments to investors comparing to those with low P/E ratios. A high P/E ratio implies high expectations for the company.

Historically, the average P/E ratio on the market has been around 15 to 25, although this can fluctuate significantly depending on the economic climate. The P/E ratio can also vary widely between industries and different companies.

The P/E Ratio often falls under other names including earnings multiple, or simply multiple.