Price/earnings (P/E) ratio

Definition

The Price/Earnings (P/E) ratio is a valuation metric that compares a company's current share price to its earnings per share (EPS). It indicates how much investors are willing to pay for each dollar of earnings, serving as a gauge of market expectations and valuation levels.

5 Must Know Facts For Your Next Test

1. A high P/E ratio can indicate that a stock is overvalued or that investors expect high growth rates in the future.
2. A low P/E ratio might suggest that a stock is undervalued or that the company is experiencing difficulties.
3. The P/E ratio is calculated by dividing the market value per share by the earnings per share (EPS).
4. There are two types of P/E ratios: trailing P/E, which uses past earnings data, and forward P/E, which uses projected future earnings.
5. The average P/E ratio varies across different industries; comparing companies within the same sector provides more meaningful insights.

Review Questions

• How do you calculate the Price/Earnings (P/E) ratio?
• What could a high P/E ratio indicate about investor expectations?
• Why might it be more useful to compare P/E ratios within the same industry?

Related terms

Earnings Per Share (EPS): A financial metric that indicates how much profit a company makes for each outstanding share of its stock.

Market Value: The current price at which an asset or service can be bought or sold in the marketplace.

Forward P/E Ratio: A version of the P/E ratio that uses forecasted earnings for its calculation instead of historical data.