The Corporate Finance Institute
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A. Price Ratios
Price ratios use the most recent company share price to drive insights about company value for financial analysts. These ratios are quick to calculate but can be affected by different accounting policies and treatment.
Price-to-Earnings Ratio Corporate Finance Institute
Financial Ratios
Price-to-Earnings (P/E) Ratio Overview The price-to-earnings (P/E) ratio compares a company’s stock price with its earnings per share (EPS). This ratio is commonly used as a valuation metric to compare the relative value of different companies. The P/E ratio shows the expectations of the market and is the price paid per unit of current earnings.
Formula
Interpretation To calculate this ratio, the following formulas are required:
Earnings per Share = (Net Income – Preferred Dividends)/Weighted Avg. Shares Outstanding Companies with a high P/E ratio are often considered growth stocks. This indicates positive future performance and earnings growth as investors are willing to pay more per dollar of current earnings. However, growth stocks are usually more volatile and have more investor pressure to perform well. Stocks with high P/E ratios may also be considered overvalued.
Conversely, companies with a low P/E ratio are often considered value stocks. They are undervalued relative to their competitors and company intrinsic value. These stocks are a bargain that investors aim for before the markets correct their valuations on them.
The P/E ratio can also be used to compare stocks at different prices. For example, if Stock A is trading at $30 and Stock B at $20, Stock A appears to be more expensive. However, if Stock A had a lower P/E ratio than Stock B, its price per unit of earnings would be lower than Stock B, thus making Stock A cheaper from an earnings perspective.
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