Price-to-Earnings P E Ratio: Definition, Formula, and Examples

Bank of America’s P/E at 19× was slightly higher than the S&P 500, which over time trades at about 15× trailing earnings. The P/E ratio of the S&P 500 going back to 1927 has had a low of roughly 6 in mid-1949 and been as high as 122 in mid-2009, right after the financial crisis. A financial professional will offer guidance based on the information provided and offer a no-obligation call to better understand your situation. Someone on our team will connect you with a financial professional in our network holding the correct designation 23 of the best accounting events to attend in 2020 and expertise. Ask a question about your financial situation providing as much detail as possible. Our team of reviewers are established professionals with decades of experience in areas of personal finance and hold many advanced degrees and certifications.

Before investing, it’s wise to use various financial tools to determine whether a stock is fairly valued. However, there are problems with the forward P/E metric—namely, companies could underestimate earnings to beat the estimated P/E when the next quarter’s earnings arrive. Furthermore, external analysts may also provide estimates that diverge from the company estimates, creating confusion. The most commonly used P/E ratios are the forward P/E and the trailing P/E. A third and less typical variation uses the sum of the last two actual quarters and the estimates of the following two quarters.

As well, if the projections are accurate, it can give investors an insight into stocks that are likely to soon experience growth. A high P/E ratio for, say, a particular utilities company isn’t necessarily a problem if many other utilities companies in the industry tend to have high P/E ratios. The industry of the company, the state of the overall market, and the investor’s own interpretation can all affect how they evaluate a particular P/E ratio. The P/E ratio is derived by taking the price of a share over its estimated earnings. To illustrate the calculation process, let’s go through a market price per share example.

P/E ratios can be misleading if looked at without considering a company’s recent history. A simple way to think about the P/E ratio is how much you are paying for one dollar of earnings per year. High P/E ratios must also be interpreted within the context of the entire industry.

What Is the Price-to-Earnings (P/E) Ratio?

The earnings yield is another valuation metric that is simply the inverse of the P/E ratio (the E/P ratio). For example, the average PE ratio can be measured across entire stock indexes, markets, sectors, industries, and countries. Another way to calculate the PE ratio is by dividing the company’s market cap with its total net income. You can find the stock price and EPS by entering the stock’s ticker symbol into the search form of various finance and investing websites. That’s because, again, FCFE relates exclusively to equity investors, whereas FCF relates to both debt as well as equity investors. There are a variety of ways to calculate the stock price, so let’s now look at the different ways.

Although the PE ratio is useful to get a quick idea of a company’s valuation, it is still just one part of a complicated puzzle. Investing based on the PE ratio alone is a bad idea because cheap stocks are often cheap for a good reason. Many finance websites (including Stock Analysis) don’t show the PE ratio if EPS is negative because a negative PE ratio isn’t very informative. Looking at PE ratios and other valuation metrics before investing can help protect you from getting swept up in bubbles, fads, and manias.

Examples of the P/E Ratio

Some investors might compare the PE ratio of the US stock market and the European stock market to find out which one might have better investments. One useful way to check if a stock’s PE ratio is reasonable is to also look at a related metric that incorporates the company’s earnings growth rate. P/E Ratio, or the Price-to-Earnings ratio, is a metric measuring the price of a stock relative to its earnings per share (EPS). Trailing P/E ratios are derived from the earnings per share of a stock over the last 12 months, rather than future projections. Forward P/E ratios can be useful for comparing current earnings with future earnings to estimate growth.

How to Calculate Stock Price Based on Market Cap

1. For equity investors who earn periodic investment income, this may be a secondary concern.
2. You calculate the PE ratio by dividing the stock price with earnings per share (EPS).
3. Furthermore, external analysts may also provide estimates that diverge from the company estimates, creating confusion.
4. It is essential to consider other valuation metrics and evaluate the company’s future growth prospects.

The relative P/E compares the absolute P/E to a benchmark or a range of past P/Es over a relevant period, such as the past 10 years. The relative P/E shows what portion or percentage of the past P/Es that the current P/E has reached. The relative P/E usually compares the current P/E value with the highest value of the range. Investors might also compare the current P/E to the bottom side of the range, measuring how close the current P/E is to the historic low.

Components of the P/E Ratio

A high P/E ratio indicates that investors are willing to buy the shares of the company at a higher price. In other words, we can say that an investor who purchases the company’s shares is willing to pay $20 for each dollar of earnings. That said, some types of industries inherently have lower or higher PE ratios than others, mostly because of different growth prospects or business conditions. By looking at average PE ratios, it is possible to get an idea of whether entire sectors, industries, or markets are over- or undervalued. Others may use the PE ratio to compare the valuation of different industries, bond issue cost journal entry such as comparing the technology industry to the financial industry.

A company’s P/E ratio can be benchmarked against other stocks in the same industry or the S&P 500 Index. A P/E ratio of 15 means that the company’s current market value equals 15 times its annual earnings. Put literally, if you were to hypothetically buy 100% of the company’s shares, it would take 15 years for you to earn back your initial investment through the company’s ongoing profits. However, that 15-year estimate would change if the company grows or its earnings fluctuate. The last alternative to consider is the enterprise value-to-EBITDA (EV/EBITDA) ratio. It assesses a company’s valuation relative to its earnings before interest, taxes, depreciation, and amortization.