The Price-to-Earnings Ratio is a company valuation metric that compares the current share price to the earnings per share. This ratio gives the value investors give to each dollar of future earnings.
Company X has a market value per share of $100 and earnings per share of $5. The P/E Ratio is 20, meaning that investors are willing to invest $20 for each dollar of future earnings.
General guidelines are that stocks with less than 15 P/E Ratio are considered cheap while a P/E Ratio above 18 is considered expensive. However, this depends on your view of valuation metrics. If you favour growth over current value, then higher P/E Ratios are more acceptable. Investors who favour stocks with lower P/E Ratios do so because of the reduced risk associated with low P/E Ratios.
The P/E Ratio is best represented as a single dollar value, easy for you to refer to and have this number at your fingertips. Take a look at the example summary chart for one way to visualize your P/E Ratio data:
The Price-to-Earnings Ratio, also known as the price multiple or earnings multiple, is a metric commonly used by investors to determine the valuation of the stock of a company. The ratio divides the market value per share by earnings per share to give the value of each dollar of earnings. Interpretation of P/E Ratio is totally dependent on each investor’s approach to company valuation. A high P/E Ratio can indicate that a stock is expensive or overvalued but can also be an indicator of future growth potential.
P/E is classified into trailing P/E and Forward P/E, although the standard ratio is trialing P/E. The difference between the two classifications is that Forward P/E uses the future forecast value of market share price to calculate the P/E Ratio, while trailing P/E uses current market share price.
