Price to Earnings Ratio Calculation
When evaluating a stock, most investors refer to the Price to Earnings (P/E) ratio in order to make more reasonable investment decisions. It is the ratio most often used by investor when it comes to evaluating stocks. However, it should not be used in isolation, but instead be combined with other tools for stock evaluation.
As with other ratios, the P/E reflects a relationship between the price of the stock and the earnings of the company. Since, the P/E is commonly used, other stock analysis tools should not be overlooked.
Price to Earnings (P/E) Ratio Formula
The following formula should be implemented for the calculation of the P/E:
P/E = Share Price / EPS
Example: Company ABC has a price per share of $30. Its Earnings per Share (EPS) is 5. Therefore, company ABC's P/E will be 6, which is received by dividing $30 by 5.
What is the meaning behind P/E?
The amount you get for a company's P/E represents the money the market is willing to pay for the earnings the company makes. Logically, a higher P/E means that the market is ready to pay more for the earnings of the company. Another interpretation of the value of P/E may be that the market places high expectations regarding the performance of the stock. A high value of P/E is often times interpreted as the stock being overpriced.
On the other hand, if the value of the P/E is low many investors interpret it is lack of confidence in the future performance of the stock and the company respectively. Another interpretation is that the market has failed to value accurately the stock. Being overlooked by the market, many investors that are capable of finding such stocks make a real fortune by investing them at the right time before their potential is found by the other investors.
The Right P/E
The suitability of a P/E may depend on the willingness of investors to pay for the generated by the company earnings. So, the higher the investor is willing and able to pay, the higher the value of the P/E. This means that the investor has perceived some potential in the long-term growth and performance of the company. Additionally, the right level of P/E is highly subjective since it depends on the personal view of every investor.
Rate this article : Low | High |
- Pick the Best Stock Type for You
- Cyclical vs Non-Cyclical Stocks
- Dividend Yield Calculation and Drawbacks
- Book Value Explanation
- Dividend Payout Ratio Calculation
- Dividend Yield Explanation
- Stock Beta Value
- Operating Cash Flow Implications
- Stock Valuations - Key Interest Rates Relationship
- Price to Book Ratio Calculation
- Return on Equity Calculation and Drawbacks
- How to Benefit from Short Sellers
- Earnings per Share EPS Calculation
- PEG Ratio Calculation
- Simple Return vs Compound Annual Growth Rate Formula
- Price to Cash Flow Ratio vs Free Cash Flow
- Institutional Investors and Their Influence on Stock Trading
- Company Valuation Methods - Debt Evaluating
- Company Valuation Methods - Management Effectiveness Ratios
- Company Valuation Methods - Debt Evaluation Formulas
- Determining the Right Stock Price
- The Importance of Earnings in Evaluating Stocks
- Price to Sales Ratio Calculation
- Cash Flow Valuation
- Calculate Return on Investment
- Relative Strength Indicator
- Non-Financial Characteristics of a Successful Stock
- Per-Share Price vs Market Cap
- Value Stocks vs Growth Stocks
- Identifying a Value Stock
- Small Cap Stocks Opportunities and Risks
- Stock Analyst Recommendations - Should We Trust Them?
- Value - Growth Stocks Comparison
- Investing in Hedge Funds: Pros and Cons
- Price to Sales Ratio (PSR) Explanation
- Funds of Hedge Funds
- Investing in Interval Funds
- How to Select a Winning Stock from a 52-Week List
- Earnings Estimates and Stock Selection