Price to Earnings Ratio (PE Ratio)
PE Ratio Formula
Similar names: The price-earnings ratio, P/E ratio, P/E, PER.
What is P/E Ratio and What Does P/E Ratio Tell You?
PE ratio is calculated by dividing the share price by earnings per share.
Price to earnings ratio can be used to identify whether the company’s stock price is overvalued or not by comparing it with the industry average value.
The ratio demonstrates how many years it takes to cover the price, as per the current earning rate. For example, PE ratio 10 means the company will take 10 years to earn to cover the share price. Because the share price is 10 times bigger than the earnings per share.
Normally PE ratio is calculated for the previous 12-month data (TTM).
What does it mean by a high P/E Ratio?
A high P/E ratio compared to its industry could mean that a company's stock is overvalued.
Some times investors may expect higher earnings if the PE ratio is high. This may happen due to political changes or decisions, social and environmental changes. Experienced investors might be able to predict this type of sudden price variations by analyzing company records, market demand and the news related to the company business.
Buying stocks with a high PE ratio means putting your money at huge risk. For starters, this may be a huge risk for your money. So don’t go for such investments if not certain.
What does it mean by a low P/E Ratio?
Companies with a low P/E ratios compared to its industry may indicate that the stock is undervalued. This means the company share price is cheaper compared to its industry average.
If the company's share price is undervalued, the share price may go up due to investors' demand.
How to use PE Ratio?
Usually, investors prefer to invest in shares with a low PE ratio because there is a good chance of climbing the share price.
Risk of using PE Ratio and when not to use PE ratio
Sometimes due to low growth company or companies losing money may have a low PE ratio.
A stock with a high P/E ratio can be a high risk investment because the stock may be overvalued.
So never take decisions by only looking at PE ratio. Always analyze as possible by considering different factors like other ratios and business news. Always try to use multiple ratios combinedly to get a more clear picture of a company.