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 pershare 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:
 It is based on reported earnings, "accounting profits", which are not
a good indicator of actual value creation for shareholders.
 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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Compare with the P/E Ratio: PEG Ratio
 Market Value Added 
EBIT 
EBITDA 
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Return on Equity 
TSR 
PRVit
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