P/E Ratio (Price to Earnings Ratio)

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Measuring market performance. Explanation of P/E ratio.

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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
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  What is the meaning of X in PE Ratio?
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  Conflict of Interest of Management Buy Out
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  Relevance of PE Ratio for CEO
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  Why Using Average P/E Ratio is More Realistic
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P/E Ratio Special Interest Group


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P/E Ratio Education & Events


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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...
Usage (application): Analyzing Reported Earnings
 
 
 

What is the Degree of Management Discretion or Manipulation?

The discretionary nature of income recognition per...
Usage (application): Analyzing Reported Earnings
 
 

Resources - P/E Ratio Premium

Financial Statement Analysis | Ratio Analysis

This presentation provides insights in Financial s...
Usage (application): Ratio Analysis, Finanical Statement Analysis
 

Business Valuation | Company Valuation | Firm Valuation

This presentation elaborates on the valuation and ...
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 financ...
Usage (application): Types of Financial Ratios, Financial Ratio Analysis, Financial Ratio Types
 

P/E Ratio Diagram

Download and edit this 12manage PowerPoint graphic...
Usage (application): Analyzing Stock Performance
 
 

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


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