Price to earnings ratio: Difference between revisions

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imported>Doug Williamson
(Clarify.)
imported>Doug Williamson
(Explain more appropriate uses of PE ratios.)
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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.
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.





Revision as of 11:28, 14 April 2015

(PER).

The ratio of the equity value 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 value and total earnings, giving identical results.


Per share:

PE ratio = Current share price ÷ Earnings per share.


On total values:

PE ratio = Total equity value ÷ Total earnings.


For example if Company A's total equity value 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.

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:

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.


See also