Price to earnings ratio: Difference between revisions
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(PER). | (PER). | ||
The ratio of the equity | The ratio of the equity capitalisation of a company to its accounting earnings (profit after tax). | ||
The PER (or PE ratio) can be calculated either on a per-share basis or on the total equity | The PER (or PE ratio) can be calculated either on a per-share basis or on the total equity capitalisation and total earnings, giving identical results. | ||
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On total values: | On total values: | ||
PE ratio = Total equity | PE ratio = Total equity capitalisation ÷ Total earnings. | ||
<span style="color:#4B0082">'''Example 1'''</span> | <span style="color:#4B0082">'''Example 1'''</span> | ||
Company A's total equity | Company A's total equity capitalisation is $630m and its relevant earnings are $63m, | ||
the PE ratio = $630m / $63m | the PE ratio = $630m / $63m | ||
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In another case, say comparable PE ratios for an unlisted Company B are 12, and Company B's relevant earnings are $10m. | In another case, say comparable PE ratios for an unlisted Company B are 12, and Company B's relevant earnings are $10m. | ||
The total value of Company B's equity can be estimated on this basis as: | The approximate total value of Company B's equity can be estimated on this basis as: | ||
12 x $10m | 12 x $10m | ||
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* [[Bootstrap effect]] | * [[Bootstrap effect]] | ||
* [[Capitalisation]] | * [[Capitalisation]] | ||
* [[Cyclically Adjusted Price to Earnings ratio]] | |||
* [[Dividend yield]] | |||
* [[Earnings]] | * [[Earnings]] | ||
* [[Earnings multiples]] | * [[Earnings multiples]] | ||
Latest revision as of 19:42, 22 April 2023
(PER).
The ratio of the equity capitalisation of a company to its accounting earnings (profit after tax).
The PER (or PE ratio) can be calculated either on a per-share basis or on the total equity capitalisation and total earnings, giving identical results.
Per share:
PE ratio = Current share price ÷ Earnings per share.
On total values:
PE ratio = Total equity capitalisation ÷ Total earnings.
Example 1
Company A's total equity capitalisation is $630m and its relevant earnings are $63m,
the PE ratio = $630m / $63m
= 10.
The Price to earnings ratio reflects the market's perception of the risk and the future growth prospects of the company.
A higher PE ratio generally indicates that the market perceives:
- better growth
- lower risk
- or both
Lower PE ratios suggest lower growth (or indeed decline), higher risk, or both
PE ratios can also be used as a very simple estimation or comparison model, for corporate valuation.
Example 2
In another case, say comparable PE ratios for an unlisted Company B are 12, and Company B's relevant earnings are $10m.
The approximate total value of Company B's equity can be estimated on this basis as:
12 x $10m
= $120m.
Very simplistically, shares trading on low PE ratios might be perceived as relatively cheap. Similarly, shares trading on higher PE ratios would be seen as relatively expensive.
A better use of PE ratios is as a sense-check of the results and insights from other valuation methods.
Sometimes written as P/E ratio.
Also known as price earnings ratio.
