A valuation ratio of a company's current share price compared to its per-share earnings.
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The ratio of share price to the company's earnings per share.
Eg If the share price is $1 and the company earned 5 cents per share last year then that's a p/e ratio of 20.
Something to be aware of is that not all companies actually have earnings. That is, whilst most companies would aim to make a profit over the long term at least, there are plenty who for whatever reason didn't actually make money over the past 12 months.
No earnings = no p/e ratio.
Again, its not that i don't want to help you, but your journey to enlightenment will be faster with some searches of your own too, instead of waiting for members answers.
Enjoy your journey...
This is a simple but very useful ratio, one i think is often misunderstood or not used properly.
PE Ratio = Price / Earnings.
That hard part is estimating the Earnings. What's often reported is the current reported earning... what you want to do is to find the company's real earning power. This can be its average earnings over the past 5 years, or a conservative estimate of its near term earnings, could be its currently reported earnings, could be a combo of all these. So which is it? Depends on your understanding of the company's business and operations.
Once you can gauge the earnings, what Warren Buffett does is this:
Assume that you were to buy the entire company, and so all that earnings is yours. Then there's the asking price (the stock market price)...
So if the company earns, on average, $1 a share, maybe $1.20... and it's selling for $10 to $12. That' sa PE ratio of 10, inverse that and what are you getting for your money from the day you bought it until eternity?
1/10 = 10%... So the higher the ratio, the lower return you're going to get from your investment.
The future might be different, very different. Say the company now earns $1 a share... but in the not too distant future, it could earn $2 a share.. so a 10 PE ratio is actually a 5 PE ratio etc. etc.
But no one can predict the future... the best you can do is assume the future will be pretty much the same as it has been for this company all these time. i.e., the cmpany will grow at a reasonable rate, won't go bankrupt, won't be destroyed by competition.
These kind of companies are usually ones that dominate their industry, their industry are stable, not prone to technological changes or requiring large capital expenditures etc. etc.
But of course it's not that straight forward either...
From Phillip A Fisher's Common Stock & Uncommon Profit, he argued that a simple PE ratio of low is better and higher PE companies or expensive is not true. That if a company is worthwhile, know what it's doing, its future will always be brighter than it is or has been, and the market know this so will priced its stock at a higher multiple to current earnings... so as long as you study the company, know its prospects, happy with its current and future sales and earnings, a higher PE ratio stock would always remain relatively higher PE because it deserves to be... but a lower PE now might prove a disaster in a couple of years if its earnings fell off a cliff.
In short, it depends.
use these statistical figures in context with the business itself, not as an indication of good or cheap or bad company to buy.
Though in general, be conservative... you don't want to pay for a future that might never happen.
That explanation is excellent Luutzu. If you are willing to share your reasoning :-
I am wondering why share prices are very high multiples of the company earnings per share? Could this ratio be meaningless because it is by expectation that these multiples are arrived? A rising share is evident in the plotted price so what use is a P/E ratio?