PE Ratio (Price to Earnings) Definition

The PE ratio is the current share price relative to its EPS, used to help value a company.

The P/E (Price to Earnings) is a world-renowned ratio used by value and non-value investors, it is considered to be one of the most useful metrics in valuing a company. Alternative names given to the PE ratio include Price multiple as well as Earnings multiple. The P/E ratio works well in measuring how much each pound or dollar of earnings is worth for a particular company.

The formula to determine the P/E value of a company is derived as;
Price per Share divided by Earnings per Share

The Price per Share may be the current stock price or latest closing price. The Earnings per Share value may be historic or estimated. If historic this may be the TTM (trailing 12 months) value or the latest fiscal year value, the estimated would typically be based on the next 12 months (forward).

Companies with higher P/E values are generally seen as those with greater future growth prospects, a sign that investors are expecting higher earnings. Companies with lower P/E values are seen as those with lacking future growth prospects. On the other hand, a company with a higher P/E could potentially indicate it is being overvalued and may not reach the expected higher earnings. A company with a lower P/E may be signalling it is being undervalued, meaning for profit in future.

It is important to research a company carefully, the P/E although frequent and popular. Used alone and without context is not enough. To help justify the P/E value further one could compare it against similar companies i.e. within the same industry or against the market it is in. Comparing a company's P/E value against its historical P/E values can also be especially valuable information.

The P/E ratio acts as an excellent complimentary tool that should certainly be used with other metrics when evaluating a company.

You may also be interested in: