Price/Earnings Ratio (P/E Ratio)

P/E Ratio Meaning

The Price/Earnings Ratio (P/E Ratio) is a ratio used by investors to help evaluate how cheap or expensive a company’s stock is.  P/E ratios are used by investors and analysts to determine the relative value of a company’s shares in an apples-to-apples comparison. It can also be used to compare a company against its own historical record or to compare aggregate markets against one another or over time.

Price Earnings Ratio Formula

The P/E Ratio is calculated by dividing a stock’s price by its earnings per share. As an example, a stock with a price of $90 and earnings per share of $10 has a P/E Ratio of 9 (90/10).

Companies that have no earnings or that are losing money do not have a P/E ratio because there is nothing to put in the denominator.

What Is a Good Price-To-Earnings Ratio

The P/E ratio is merely one tool that investors can use to help assess whether a company is under or overvalued.  The P/E ratio is most commonly used to compare companies which operate in the same industry or to compare a company’s current valuation to its history over time.

Is High or Low PE Ratio Better?

There is no hard and fast rule to determine whether a P/E ratio is “good” or “bad”.  A high P/E ratio could mean that a company’s stock is overvalued, or that investors are expecting high earnings growth rates in the future.  Conversely, a low P/E ratio could indicate that a company is undervalued, or that the market recognizes a potential decline in earnings is imminent.

There are a wide variety of inputs which analysts might use to help them determine whether a company is a good investment or not.  Investors should be careful when making blanket statements about a company’s valuation based on P/E ratio alone.

 

Wealthspire Advisors is a registered investment adviser and subsidiary company of NFP Corp.
This information should not be construed as a recommendation, offer to sell, or solicitation of an offer to buy a particular security or investment strategy. The commentary provided is for informational purposes only and should not be relied upon for accounting, legal, or tax advice. While the information is deemed reliable, Wealthspire Advisors cannot guarantee its accuracy, completeness, or suitability for any purpose, and makes no warranties with regard to the results to be obtained from its use. ©2022 Wealthspire Advisors

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