P/E Ratio (Price to Earnings Ratio)

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Measuring market performance. Explanation of P/E 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 -

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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 firm’s 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

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