P/E Ratio

Price to Earnings ratio

Measuring market performance:

Summary of P/E Ratio. Abstract

P/E Ratio Price to Earnings ratio

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. Even if Discounted Cash Flow is a superior method to value a company, sometimes investors prefer to use simpler methods.

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 to "pay you back".

For example, a company that earned $10M last year, with a million shares outstanding, had earnings per share of $10. If that company's stock currently sells for $100 per share, it has a P/E of 10. Stated differently, at this price, investors are willing to pay $10 for every $1 of last year's earnings.

The price to earnings (P/E 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 earnings, accounting profits, which are not a good indicator of actual value creation for shareholders - more.

2. what multiplier should be used? The industry average? Often corrections are made based on: the company's expected growth, 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

T I P : Here you can discuss and learn a lot more about relative company performance and the P/E Ratio.

More valuation methods

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