P/E ratio definition

What is the P/E ratio?

The price-to-earnings ratio, or P/E ratio for short, compares a company’s current stock price to its current earnings. People use it to show whether a company’s shares are currently overpriced compared to the earnings that it’s generating.

 

What’s a good P/E ratio? 

Typically, a higher P/E ratio suggests that investors expect a company to achieve high earnings and strong growth in the future. Because of this, a high P/E ratio often means that you’re paying more money in the present for a higher probability of future earnings.

For example, a P/E ratio of 20 means that people are willing to pay $20 in the present for every $1 of a company’s earnings in the future. A P/E ratio of $100 means that people accept that they’ll pay 100 times the current stock price for every $1 of future earnings – which means they are more confident that the company will generate earnings and profits in the future.

Generally, investors are willing to pay more for future earnings if the company’s stock price is expected to rise in the future.

That said, a low P/E ratio isn’t a bad thing. It’s sometimes taken as an indicator that a company’s stock is undervalued, or as a sign that current earnings are exceeding what the company has historically achieved.

 

How to calculate the P/E ratio

To calculate the P/E ratio, you’ll need to divide the company’s current share price by its earnings per share (EPS). Finding these two stats is relatively easy, just type the name of the company into a search engine followed by ‘current share price’ or ‘earnings per share’ – ‘Company ABC share price’ for example.

Companies that don’t generate earnings or that are losing money won’t have a P/E ratio because there’s no earnings per share to divide the current share price by.

 

Learn more about earnings per share