What is Price Earnings Ratio
Price earnings ratio is a financial ratio that measures the stock valuation by a comparison between the current market price per common stock and the company’s earnings per share (EPS). The price-earnings ratio helps the investors to determine the growth potential, earnings stability, and furthermore how many years the investor will reach the break-even point when investing in a single stock.
The price-earnings ratio (P/E ratio) investors’ assessment of the company’s future earnings by evaluating how much investors pay for each $1 of earnings from that stock and comparing the price earnings ratio between a company within the same industry (or with other choices) to determine whether a stock is overvalued or undervalued.
The price-earnings ratio is also known as the P/E ratio, PE, PER, and the price-to-earnings ratio.
High & Low Price Earnings Ratio
The ratio of price to earnings will be higher when the investors think the company’s earnings will increase substantially in the future and therefore are willing to pay more per share of stock (when the price of a stock rises, its P/E ratio rises).
In contrast, the price earnings ratio will be lower when the investors think the company’s future earnings will not be strong due to its poor quality earnings, and then sell them (when the price of a stock fall, its P/E ratio will be lower).
To put it simply, the higher P/E ratio indicates that investors pay more to buy a share due to the expectation of future earnings and vice versa. For example, a P/E ratio of 5 means that the investors are happy to buy a share for $20 per share of $1 of earnings.
Keep in mind, that the price earnings ratio depends on the market’s expectation of stock and doesn’t include the company’s debt or reflect any financial structure. For example. the company that grows faster than the average will have a higher P/E ratio, the investors still buy them although it’s a high P/E because of the growth expectations. In the same way, a stock with a low P/E ratio doesn’t always be a good sign of buying them.
Price Earnings Ratio Formula
The price-earnings ratio can be calculated by dividing a current share price per share (also known as the market price) by earnings per share (EPS) as the following price earnings ratio formula:
- P/E Ratio = Current Share Price / Earnings per Share
Note: a company with losses or negative earnings per share will be expressed as N/A (not applicable).
Let’s say the current Feriors stock price at the end of the day is $60, and the earnings per share of $8. The P/E ratio will be: P/E = 60 / 8 = 7.5
The company’s price earnings ratio of 7.5 means that the investors buy a share for $20 of $1 of earnings.
Frequently Asked Questions
Price earnings ratio is a financial ratio that measures the stock valuation by a comparison between the current market price and earnings per share (EPS). The PE ratio helps the investors to determine how whether a stock is overvalued or undervalued, and how many years the investor will reach the break-even point when investing in a single stock to determine whether a stock is overvalued or undervalued.
The price-earnings ratio can be calculated by dividing a current share price per share (also known as the market price) by earnings per share (EPS) as the following formula: P/E Ratio = Current Share Price / Earnings per Share
A lower P/E ratio is a good price-earnings ratio. However, a stock with a low P/E ratio doesn’t always be a good sign of buying them.
References: Wikipedia, J.P. Morgan
