P/E Ratio (Price to Earnings Ratio)

Knowledge Center

   

Measuring market performance. Explanation of P/E ratio.

Contents

  1. Summary
  2. Forum
  3. Best Practices
  4. Expert Tips
  5. Resources
  6. Print

P/E Ratio Price to Earnings ratio

What is the P/E Ratio? Description

The Price to Earnings ratio (P/E ratio) is a valuation ratio of a company's current share price compared to its per-share earnings. Discounted Cash Flow is a superior method to value a company. However sometimes investors prefer to use simpler methods.


Calculation of P/E Ratio. Formula

The P/E ratio is used for measuring market performance and can be calculated as:


P/E ratio calculation: Market Value per Share : Earnings Per Share normally for a twelve month period.

 

Often the P/E ratio is used, because it is so easy to grasp: If you buy stock at a P/E ratio of 10, say, this means it will take 10 years for the company's earnings to add up to your original investment - 10 years before you are paid back.


Example of Price to Earnings Ratio calculation

Take for example a company that earned $10M last year, and had given out 1 million shares in total. Earnings per share are $10. If that company's shares currently sell for $100 per share, it has a P/E ratio of 10. Stated differently, at this price, investors are willing to pay $10 for every $1 of last year's earnings.
 

Limitations of the P/E Ratio

The Price to Earnings ratio assumes that the corporation will be worth some multiple of its future earnings. This method has at least two drawbacks:

  1. It is based on reported earnings, "accounting profits", which are not a good indicator of actual value creation for shareholders.
  2. What multiplier should be used? The industry average? Often corrections are made based on: the expected growth of the company, the rate of return on new capital and the costs of capital (WACC)

Book: Steven M. Bragg - Business Ratios and Formulas : A Comprehensive Guide -

Book: Ciaran Walsh - Key Management Ratios -


P/E Ratio Forum
  When is Stock Overbought and Oversold?
WHEN IS STOCK OVERBOUGHT?
"Overbought" refers to a condition in which the demand for a certain asset unjustifiably pushes the price of an underlying asset to rise to such a degree that it does not support the fundamentals. This is generally inte...
     
 
  High PE Ratio Means What? A Good Stock?
What is the meaning if Company A has been trading at a higher PE ratio than company B?
Does it mean we should buy this stock or not?
Can anyone explain? Thanks......
     
 
  What is the meaning of X in PE Ratio?
Sometimes PE Ratio is given as 12.9x... What does "x" mean?...
     
 
  What is the Beta of a Stock?
Before we're investing in a stock, we not only consider the P/E Ratio, but also the Beta of that particular stock.
Beta is the measurement of how volatile the stock is when compared to the index.
In a nutshell, it can be stated that if a st...
     
 
  Conflict of Interest of Management Buy Out
If management is allowed to buy out the companies they work for, would it not be a conflict of interest in that the management can deliberately kill the P/E ratio before their acquisition?...
     
 
  Relevance of PE Ratio for CEO
What is the importance of the P/E ratio to the CEO of a company?...
     
 
  Why Using Average P/E Ratio is More Realistic
During favorable economic times (boom), company earnings are at record levels. As a result, the high stock prices and seemingly low P/E ratio's appear acceptable.
But investors are advised to use average earnings over the past 10 years or so to...
     
 

P/E Ratio Special Interest Group


Special Interest Group

P/E Ratio Education & Events


Find Trainings, Seminars and Events


Best Practices - P/E Ratio Premium

Expert Tips - P/E Ratio Premium
 

What are the Indicators of High Quality of Earnings?

The term quality of earnings usually refers to the degree of conservatism in a firmís reported earnings. Indicators of high earnings quality in...
Usage (application): Analyzing Reported Earnings
 
 
 

What is the Degree of Management Discretion or Manipulation?

The discretionary nature of income recognition permits an examination of the degree of management manipulation of earnings under one or more of the fo...
Usage (application): Analyzing Reported Earnings
 
 

Resources - P/E Ratio Premium

Financial Statement Analysis | Ratio Analysis

This presentation provides insights in Financial statement and ratio analysis, and includes the following sectios:
1. Financial analysis
2. ...
Usage (application): Ratio Analysis, Finanical Statement Analysis
 

Business Valuation | Company Valuation | Firm Valuation

This presentation elaborates on the valuation and analysis of companies and include the following sections:
1. Company analysis and stock selecti...
Usage (application): Business Analysis, Company Analysis | Firm Analysis
 

3 Minute Introduction to Financial Ratio Analysis: Why do it and What are the Main Types?

Why financial ratio analysis?
1. To compare the financial health of (similar) compani...
Usage (application): Types of Financial Ratios, Financial Ratio Analysis, Financial Ratio Types
 

P/E Ratio Diagram

Download and edit this 12manage PowerPoint graphic for limited personal, educational and business use. Republishing in intranets, websites, books, ma...
Usage (application): Analyzing Stock Performance
 
 

News

P/e Ratio
     
 

News

P/e Limitations
     
 

Videos

P/e Ratio
     
 

Videos

P/e Limitations
     
 

Presentations

P/e Ratio
     
 

Presentations

P/e Limitations
     
 

More

P/e Ratio
     
 

More

P/e Limitations
     

Compare with the P/E Ratio: PEG Ratio  |  Market Value Added  |  EBIT  |  EBITDA  |  Economic Margin  |  Return on Equity  |  TSR  |  PRVit


Return to Management Hub: Decision-making & Valuation  |  Finance & Investing


More Management Methods, Models and Theory

Special Interest Group Leader

You here


About 12manage | Advertising | Link to us | Privacy | Terms of Service
Copyright 2016 12manage - The Executive Fast Track. V14.1 - Last updated: 1-10-2016. All names tm by their owners.