Price to earnings ratio

From ACT Wiki
Jump to navigationJump to search


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.

See also