Price-to-earnings (P/E) ratio

Definition

The price-to-earnings (P/E) ratio measures a company's current share price relative to its per-share earnings. It is used by investors to evaluate the relative value of a company's shares and compare it with others in the industry.

5 Must Know Facts For Your Next Test

1. A high P/E ratio may indicate that a stock's price is high relative to earnings and possibly overvalued.
2. A low P/E ratio might suggest that the stock is undervalued or that the company is experiencing difficulties.
3. The P/E ratio can be calculated using either trailing earnings (past performance) or forward earnings (projected future performance).
4. Growth stocks typically have higher P/E ratios compared to value stocks, which tend to have lower P/E ratios.
5. The P/E ratio alone should not be used for investment decisions; it’s important to consider other financial metrics.

Review Questions

• How do you calculate the P/E ratio?
• What might a high P/E ratio indicate about a stock?
• Why should the P/E ratio not be used as the sole factor in making investment decisions?

Related terms

Earnings Per Share (EPS):

A company's profit divided by the outstanding shares of its common stock.

Dividend Yield:

A financial ratio that shows how much a company pays out in dividends each year relative to its share price.

Book Value:

The net asset value of a company calculated as total assets minus intangible assets and liabilities.