The price-to-earnings (P/E) ratio is one of the most widely used tools that investors and analysts use to determine a stock’s valuation. The P/E ratio is one indicator of whether a stock is overvalued or undervalued. Also, a company’s P/E ratio can be benchmarked against other stocks in the same industry or the .
The P/E ratio measures the market value of a stock compared to the company’s earnings. The P/E ratio reflects what the market is willing to pay today for a stock based on its past or future earnings. However, the P/E ratio can mislead investors, because past earnings do not guarantee future earnings will be the same. Likewise, projected earnings may not come to fruition.
Key Takeaways
- The price-to-earnings (P/E) ratio measures a company’s market price compared to its earnings. It shows what the market is willing to pay today for a stock based on a company’s past or future earnings.
- A company’s P/E ratio can be benchmarked against other stocks in the same industry or the S&P 500 Index.
- This helps show whether a stock is overvalued or undervalued.
Components of the P/E Ratio
Market Price
- The prevailing market price of a stock represents the “P” in P/E ratio.
- Stock price is determined by supply and demand in the market.
Earnings per Share
- Earnings per share (EPS) is the amount of profit allocated to each share of a company’scommonstock. EPS is the portion of net income that would be earned per share if all profits were distributed to shareholders.Analysts and investors use EPS to establish a company’s financial strength.
- EPS represents the “E” in P/E ratio, whereEPS = earnings ÷ total shares outstanding.
- As long as a company has positive earnings, the P/E ratio can becalculated. Acompany thatis losing money has no P/E ratio.
- EPS is often taken from a company’s last four quarters of financial results, or the trailing 12 months (TTM), and is called thetrailing EPS. However, EPScan also be taken from future earnings forecast over the coming four quarters, which is called theforward EPS.
As a result, a company will have more than one P/E ratio, so investors must be careful to compare the same P/E when evaluating and comparing different stocks.
No single ratio will tell an investor everything they need to know about a stock. Investors should use a variety of financial ratios to assess the value of a stock.
Calculating the P/E Ratio
To calculate a company’s P/E ratio, we use the following formula:
P/ERatio=EarningsperSharePriceperShare
Example of the P/E Ratio: Comparing Bank of America and JPMorgan Chase
Bank of America Corp. (BAC) closed 2017 withthe following:
- Stock Price = $29.52
- Diluted EPS = $1.56
- P/E = 18.92 or $29.52 ÷ $1.56
In other words, Bank of Americatraded at roughly 19× trailingearnings. However, the 18.92 P/E multipleby itself isn’t helpful unless you have something to compare it with, such as the stock’s industry group, a benchmark index, or Bank of America’s historical P/E range.
Bank of America’s P/E at 19× was slightly higher than the S&P 500, which over time trades at about 15× trailingearnings.
To compare Bank of America’s P/E to a peer, we calculate the P/E for JPMorgan Chase & Co. (JPM) as of the end of 2017.
- Stock Price = $106.94
- Diluted EPS = $6.31
- P/E = 16.94
When you compare Bank of America’s P/E of almost 19× to JPMorgan’s P/E of roughly 17×, Bank of America stock does not appear as overvalued as it did when compared with the averageP/E of 15 for theS&P 500. Bank of America’s higherP/E ratio might mean investorsexpected higher earnings growth in the future compared toJPMorganand the overall market.
However, no single ratio can tell you all you need to know about a stock. Before investing, it is wise to use a variety of financial ratios to determine whether a stock is fairly valued and whether a company’s financial health justifiesits stock valuation.
How Do You Benchmark a Company’s Price-to-Earnings (P/E) Ratio?
A company’s P/E ratio can be benchmarked against other stocks in the same industry or the S&P 500 Index. It helps show whether a stock is overvalued or undervalued.
What Is a P/E Ratio Composed of?
The parts of a P/E ratio are:
- Market price (the “P” in P/E ratio)
- Earnings per share (the “E” in P/E ratio)
How Do You Calculate a P/E Ratio?
Divide a company’s price per share by earnings per share (EPS), and the result is the P/E ratio.
The Bottom Line
A company’s price-to-earnings (P/E) ratio measures that company’s market price compared to its earnings. It shows what the market is willing to pay today for a stock based on the company’s past or future earnings.
FAQs
Components of P/E ratio
How to calculate PE ratio of a company? ›
P/E Ratio is calculated by dividing the market price of a share by the earnings per share. For instance, the market price of a share of the Company ABC is Rs 90 and the earnings per share are Rs 9 . P/E = 90 / 9 = 10.
What is a good PE ratio? ›
Average PE of Nifty in the last 20 years was around 20.* So PEs below 20 may provide good investment opportunities; lower the PE below 20, more attractive the investment potential.
What is the value company PE ratio? ›
The P/E ratio is calculated by dividing the market value price per share by the company's earnings per share (EPS). A high P/E ratio can mean that a stock's price is high relative to earnings and possibly overvalued. A low P/E ratio might indicate that the current stock price is low relative to earnings.
What does a PE ratio tell you? ›
Price to earnings ratio, or P/E, is a way to value a company by comparing the price of a stock to its earnings. The P/E equals the price of a share of stock, divided by the company's earnings-per-share. It tells you how much you are paying for each dollar of earnings.
What is a good PE ratio for a small business? ›
Your P/E ratio might be anywhere between one and ten, depending on your business and its growth projections. For the most part, ratios are between: 1 – 2.5 for small, owner-managed businesses.
What is the PE ratio of Tesla? ›
P/E ratio as of July 2024 (TTM): 77.2
According to Tesla's latest financial reports and stock price the company's current price-to-earnings ratio (TTM) is 77.2023. At the end of 2022 the company had a P/E ratio of 30.6.
What is Apple's current PE ratio? ›
As of today (2024-07-09), Apple's share price is $228.6786. Apple's Earnings per Share (Diluted) for the trailing twelve months (TTM) ended in Mar. 2024 was $6.43. Therefore, Apple's PE Ratio (TTM) for today is 35.56.
What is Ford's PE ratio? ›
The PE ratio for Ford Motor stock stands at 13.13 as of Jul 2, 2024. This results from the current EPS of $0.98 and stock price of $12.87. An increase of 11% has been recorded in the P/E ratio compared to the average of 11.9 of the last 4 quarters.
What does a PE of 10 mean? ›
If a company's P/E ratio is 10, that means its shares cost 10 times the profit it makes on a per-share basis in a year.
Why is Amazon PE Ratio so high? Amazon's P/E ratio is higher than most companies in the retail industry because investors are optimistic about its future growth potential. As mentioned, a high price multiple can indicate the market expects higher growth from a company.
How much PE is overvalued? ›
Investors and analysts consider stocks which have a P/E ratio of 50 or above to be an overvalued share, especially in comparison to a stock which has a ratio at par with or below 10. As it allows investors to determine that its share prices are considerably higher than what a company can afford to pay as dividends.
What is the PE value of a company? ›
Par value is the value of a single common share as set by a corporation's charter. It is not typically related to the actual value of the shares. In fact it is often lower. Any stock certificate issued for shares purchased shows the par value.
What is an excellent PE ratio? ›
Typically, the average P/E ratio is around 20 to 25. Anything below that would be considered a good price-to-earnings ratio, whereas anything above that would be a worse P/E ratio. But it doesn't stop there, as different industries can have different average P/E ratios.
How to calculate PE ratio? ›
The P/E for a stock is computed by dividing the price of a stock (the "P") by the company's annual earnings per share (the "E"). If a stock is trading at $20 per share and its earnings per share are $1, then the stock has a P/E of 20 ($20/$1).
How do you know if PE ratio is good or bad? ›
The lower the PE ratio, the better it is for investors. Example: Say, the price per share of a company is Rs 150 and its yearly earnings per share is Rs 30. Here, the PE ratio = Rs 150/Rs 30 = 5. This means buyers are willing to pay up to five times the earnings per share.
What is the formula for earnings per share ratio? ›
Earnings per share value is calculated as net income (also known as profits or earnings) divided by available shares.
What is an example of a company's P E ratio? ›
P/E Ratio Example
If the sector's average P/E is 15, Stock A has a P/E = 15 and Stock B has a P/E = 30, stock A is cheaper despite having a higher absolute price than Stock B because you pay less for every $1 of current earnings. However, Stock B has a higher ratio than both its competitor and the sector.
What is the PE ratio of a finance company? ›
The price-to-earnings ratio is one of the most highly-watched metrics used by investors to analyze whether a company warrants their investment dollars. The P/E ratio is essentially the price an investor is willing to pay for each dollar of a company's earnings.
How to calculate P/E ratio in Excel? ›
As a reminder, the formula to calculate the forward P/E Ratio is as follows: Market Share Price / Expected EPS. Place your cursor in cell D3. Please note that all formulas in Excel begin with the equal sign. Type the forward P/E formula in cell D3 as follows: =B3/C3.
