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.

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