What is the price-earnings (P/E) ratio?
The price/earnings ratio is a company's valuation ratio, which measures the current price of its shares relative to your own.earnings per share(EPS). The price-earnings ratio is sometimes also called the price multiple or earnings multiple.
Investors and analysts use price/earnings ratios to determine the relative value of a company's stock in an Apple vs. Apple comparison. It can also be used to compare a company to its own historical records, or to compare aggregate markets against each other or over time.
P/E can be estimated backwards (backwards) or forwards (forecast).
The central theses
- The price/earnings (P/E) ratio relates the price of a company's stock to its earnings per share.
- A high price/earnings ratio may mean that a company's shares are overvalued or that investors expect high growth rates in the future.
- Companies that do not make or lose money do not have P/E ratios because there is nothing to put in the denominator.
- In practice, two types of P/E ratios are used: direct and final P/E.
- A price/earnings ratio is most valuable to an analyst when comparing similar companies in the same industry or a single company over a period of time.
The price/benefit ratio explained
P/E Ratio Formula and Calculation
The formula and calculation used for this process are as follows.
Q/ERation=earnings per sharemarket value per share
fordetermine or P/L value, simply divide the current share price by earnings per share (EPS).
You can find the current share price (P) simply by pasting a stock symbol on any financial website, and while this concrete number reflects what investors are currently paying for a share, EPS is a bit more nebulous number.
EPS comes in two main varieties. TTM is a Wall Street acronym for "last 12 monthsThis number indicates the performance of the company in the last 12 months. The second type of EPS is found in a company's earnings release, which typically provides EPSguide. This is the company's best-informed estimate of what it expects to earn in the future. These different versions of EPS form the basis for the initial and final P/E.
The price/earnings (P/E) ratio is one of the most widely used tools by investors and analysts to determine the relative valuation of a stock. The price/earnings ratio helps determine whether a stock is overvalued or undervalued. A company's P/E ratio can also be compared to other stocks in the same industry or the broader market, such as the S&P 500 index.
Analysts are sometimes interested in long-term valuation trends and will consider the P/E 10 or P/E 30 ratio, which represent the average of the last 10 or the last 30 years of earnings, respectively. These metrics are often used when trying to measure the overall value of a stock index, such as the S&P 500, because these long-term metrics can smooth out changes in the index.Economy.
The S&P 500 P/E fluctuated from a low of around 5x (1917) to over 120x (2009, just before the financial crisis). The long-term average P/E ratio for the S&P 500 is approximately 16 times, which means that the stocks that make up the index earn a premium 16 times their weighted average earnings.
When to review P/L
Analysts and investors look at a company's P/E ratio when determining whether the stock price accurately reflects projected earnings per share.
Future price/earnings ratio
These two types of EPS metrics feed into the most common types of P/E: theP/U frontIt's inP/L to the right. A third, less common variant uses the sum of the last two actual quarters and the estimates for the next two quarters.
The advanced (or main) uses of profit and lossfuture earnings forecastinstead of numbers to the right. This forward-looking indicator, sometimes called an "estimated price-earnings ratio," is useful for comparing current earnings with future earnings and helps you get a clearer picture of what earnings will be, barring changes and other accounting adjustments.
However, there are inherent problems with the forward-looking P/E metric: companies can understate earnings in order to exceed the estimated P/E when next quarter's earnings are announced. Other companies may overestimate it and then adjust it in their next deal.earnings announcement. In addition, outside analysts may provide estimates that differ from the Company's estimates and cause confusion.
Final price-earnings ratio
The P/E ratio on the right depends on past performance, dividing itcurrent stock pricefor total EPS earnings in the last 12 months. It is the most popular P/E metric because it is the most objective, as long as the company has reported its earnings accurately. Some investors prefer to look at the P/E ratio because they don't trust someone else's ratio.earnings estimates. But lagging P/E also has its share of flaws, namely, a company's past performance is no guide to future behavior.
Therefore, investors must invest money in a future-oriented manner.cost effectiveness, not the past. Another problem is that the EPS number remains constant while stock prices fluctuate. If a major corporate event significantly increases or decreases the stock price, the P/E ratio will reflect less on these changes.
The bottom line price/earnings ratio changes as a company's share price moves because earnings are only released quarterly, while shares trade on a daily basis. As a result, some investors prefer the forward P/E. When the future P/E is lower than the final P/E, it means that analysts expect earnings to increase; when the expected P/E is higher than the current P/E, analysts expect a decline.
Valuation by P/L
The price/earnings, or P/E, ratio is one of the most widely used stock analysis tools by investors and analysts to determine stock valuations. P/E ratios show not only whether a company's stock price is overvalued or undervalued, but also how a stock's valuation compares to its industry or a benchmark like the S&P 500 Index.
Essentially, the price/earnings ratio indicates the dollar amount an investor will likely have to invest in a company in order to receive $1 of that company's earnings. For this reason, the P/E is sometimes called a price multiple, as it shows how much investors are willing to pay for every dollar of profit. If a company is currently trading at a P/E of 20, the interpretation is that an investor is willing to pay $20 for $1 of current profit.
The price/earnings ratio helps investors determine the market value of a stock in relation to the company's earnings. In short, the P/Eratio shows how much the market is willing to pay for a stock today based on its past or future earnings. A high P/E ratio can mean that a stock's price is high relative to earnings and may be overvalued. On the other hand, a low P/E may indicate that the current stock price is low relative to earnings.
As an example of P/L
As a historical example, let's calculate the P/E ratio for Walmart Inc. (WMT) on February 3, 2021, when the company's share price closed at $139.55.The company's earnings per share for the fiscal year ended January 31, 2021 were $4.75wall street newspaper.
Therefore, Walmart's P/E ratio was:
139,55 $ / 4,75 $ = 29,38
Comparison of companies by P/E
As another example, we can look at two financial companies to compare their P/E ratios and see which one is relatively overvalued or undervalued.
Bank of America Corporation (BAK) closed 2020 with the following statistics:
- market price= $ 30,31
- Diluted EPS= 1,87 $
- DEPORT= 16,21x (30,31$ / 1,87$)
In other words, Bank of America was trading at about 16 times net income. However, the P/E ratio of 16.21 by itself is not useful unless you have something to compare it to, such as: the stock's industry group, a benchmark, or the historical P range. /E of Bank of America.
Bank of America's P/E ratio at 16x was slightly higher than the S&P 500, which is trading at approximately 15x delayed earnings over time. To compare Bank of America's P/E to that of a competitor, we can calculate JPMorgan Chase & Co.'s P/E (JPM) from the end of 2020, in addition:
- market price= $ 127,07
- Diluted EPS= 8,88 $
- DEPORT= 14,31x
When you compare Bank of America's P/E of 16x to JPMorgan's P/E of roughly 14x, Bank of America's stock doesn't look overvalued compared to the average P/E of 15 for the S&P 500. P/E L The E-Index could mean investors were expecting higher earnings growth relative to JPMorgan and the broader market going forward.
However, no metric can tell you everything you need to know about a stock. Before investing, it's a good idea to use a variety of financial metrics to determine whether a stock is fairly valued and whether a company's financial health justifies its stock valuation.
In general, a high P/E suggests that investors expect higher earnings growth in the future than companies with lower P/Es. A low P/E ratio can indicate that a company may be currently undervalued or that the company is performing exceptionally well compared to its past trends. In both cases, if a company is not making a profit or is making a lossP/L is expressed as N/A. While it is possible to calculate a negative P/E, this is not the usual convention.
The P/E ratio can also be seen as a means of standardizing the value of a $1 gain in the stock market. In theory, by taking the median P/E ratios over a period of several years, something like a standardized P/E ratio could be formulated, which could then be viewed as a benchmark and used to indicate whether a stock is worth or worth. . not worth it. purchases.
A P/E ratio of N/A means that the ratio is not available or does not apply to that company's stock. A company can have a P/E ratio of N/A when it was recently listed and has not yet reported earnings, as in the case of an initial public offering (IPO), but it also means that a company has zero or negative earnings. , investors may therefore interpret N/A as a company reporting a net loss.
P/L vs Return on Earnings
The inverse of the P/E ratio is theperformance performance(what can be considered as an E/P relationship). Therefore, earnings yield is defined as EPS divided by the share price, expressed as a percentage.
If stock A is trading at $10 and your year-to-date EPS is 50 cents (TTM), you will have a P/E of 20 (i.e., $10/50 cents) and an earnings yield of 5% (50 cents /$10) . ). If stock B is trading at $20 and its EPS (TMT) was $2, it has a P/E ratio of 10 (ie $20/$2) and an earnings yield of 10% = ($2/$20).
Earnings yield as an investment valuation metric is not used as commonly as P/E. Earnings returns can be helpful when it comes to return on investment. However, for equity investors, generating consistent investment income may be secondary to increasing the value of their investments over time. For this reason, when investing in stocks, investors often refer to value-based investment metrics, such as P/E, rather than earnings yield.
Earnings performance is also useful for creating a metric for when a company has zero or negative earnings. Since this case is common in high-tech, growth, or startup companies, earnings per share will be negative, resulting in an undefined P/E ratio (referred to as N/A). However, if a company has a negative result, there is a negative profit return that can be interpreted and used for comparison.
P/L x PEG ratio
A price/earnings ratio, even if calculated using a futures contractearnings estimate, it doesn't always tell you if the P/E is reasonable for the company's projected growth rate. So, to get around this limitation, investors turn to a different index called the index.peg system.
A variation of the future P/E is thisprice/earnings ratio relative to growthor peg. The PEG ratio measures the relationship between price/earnings and earnings growth to give investors a more complete picture than P/E alone. In other words, the PEG Index allows investors to gauge whether a stock's price is overvalued or undervalued by looking at both today. and the expected growth rate for the company in the future. The PEG ratio is calculated as a company's price-earnings (P/E) ratio divided by the growth rate of its earnings over a given period.
The PEG ratio is used to determine a stock's value based on retained earnings, which also takes into account the company's future earnings growth and is believed to provide a more complete picture than P/E. For example, a low P/E ratio might indicate that a stock is undervalued and therefore should be bought, but looking at the growth rate of the company to get the PEG ratio might be a different story. PEG indices can be referred to as "lagging" when using historical growth rates or "leading" when using projected growth rates.
While earnings growth rates can vary in different industries, a stock with a PEG of less than 1 is generally considered undervalued because its price is considered low compared to the company's expected earnings growth. A PEG greater than 1 can be considered overvalued, as it may indicate that the stock price is too high compared to the company's expected earnings growth.
Absolute against parents kgv
Analysts can also distinguish between absolute P/E and absolute P/Ekgv parentsconditions in your analysis.
Absolute PER ratio
The numerator of this ratio is typically the current share price, and the denominator may be earnings per share (ETR), estimated earnings per share for the next 12 months (expected P/E), or an earnings per share mix of the last two quarters and the anticipated -P/E for the next two quarters.
When distinguishing absolute P/E from relative P/E, it is important to remember that absolute P/E represents the P/E of the current period. For example, if the stock price today is $100 and TTM earnings are $2 per share, the P/E ratio is 50 = ($100 / $2).
Diekgv parentscompares the current absolute P/E ratio to a benchmark or a series of past P/E ratios over a relevant period, such as B. the last 10 years. Relative P/L shows what proportion or percentage of previous P/L has reached the current P/L. Relative P/L typically compares the current P/L to the top of the range, but traders can also compare the current P/L to the lower side of the range and gauge how close the current P/L is to everyone's. the times. under.
Relative P/E will have a value below 100% if the current P/E is less than the past value (either the past high or low). When the relative P/E is 100% or higher, this tells investors that the current P/E is equal to or higher than the past value.
Restrictions on the use of P/E
As with any other set of fundamentals designed to tell investors whether or not a stock is worth buying, the price-earnings ratio has a lot going for it.limitationswhich is important to keep in mind, as investors often believe that there is a single metric that provides complete information about an investment decision, which is almost never the case.
Companies that are unprofitable and, as a result, have no earnings, or negative earnings per share, present a challenge when it comes to calculating their P/E ratio. Opinions differ on how to handle this. Some say there is a negative P/L, others assign a P/L of 0, while most simply say that the P/L does not exist (N/A orNot available) or only interpretable when a company becomes profitable for comparison purposes.
A primary limitation of using P/E ratios comes from comparing the P/E ratios of different companies. Company valuations and growth rates often vary widely across industries, both because of the different ways companies make money and the different timeframes over which companies make that money.
Therefore, P/E should only be used as a comparison tool when looking for companies in the same industry, as this type of comparison is the only one that provides productive information. Comparing the price/earnings ratios of, say, a telecommunications company and a power company may lead you to believe that it is clearly the better investment, but that is not a reliable assumption.
Other profit and loss considerations
The P/E ratio of an individual company is much more meaningful when viewed in conjunction with the P/E ratios of other companies in the same industry. For example, an energy company may have a high P/E, but this may reflect a trend within the industry rather than just within an individual company. For example, the high P/E of an individual company would be less of a concern if the entire industry had a high P/E.
How a company's debt can affect share prices and company profits,Take advantage ofit can also distort the P/E. Suppose there are two similar companies that differ primarily in the amount of debt they take on. The one with the most debt is likely to have a lower P/E ratio than the one with the least debt. However, if business goes well, those with more debt will earn more for the risks they take.
Another important limitation of the price/earnings ratio is the formula used to calculate the P/E ratio itself. Accurate and unbiased price/earnings presentations are based on accurate inputs of stock market values and accurate estimates of earnings per share. The market determines the prices of the shares through its ongoing auction. Printed prices are available from several reputable sources. Ultimately, however, the source of earnings information is the company itself. This single source of data is easier to manipulate, giving analysts and investors confidence that company executives are providing accurate information. When that trust is broken, the stock is considered riskier and therefore less valuable.
To reduce the risk of misinformation, the price-earnings ratio is just one metric closely scrutinized by analysts. If the company deliberately tampered with the numbers to make itself look better, misleading investors, it would have to make an effort to ensure that all metrics are tampered with consistently, which is difficult. That's why P/E remains one of the most central data points in a company's analysis, but it's not the only one.
What is a good price/benefit ratio?
The question of what constitutes a good or bad price/earnings ratio inevitably depends on the industry in which the company operates. Some industries will have higher average price/earnings ratios, while others will have lower ratios. For example, in January 2021, public broadcasters had an average P/E of around 12, compared to more than 60 for software companies.If you want to get an overview of whether a particular P/E is high or low, you can compare it to the average P/E of competitors in your industry.
Is it better to have a higher or lower P/E ratio?
Many investors will tell you that it's better to buy stocks in companies with lower P/E ratios because that means you're paying less for every dollar of earnings you earn. In that sense, a lower P/E is like a lower price, making it attractive to bargain-hunting investors. In practice, however, it's important to understand a company's P/E ratios. For example, if a company has a low price/earnings ratio because its business model is fundamentally in decline, what appears to be a bargain may be an illusion.
What does a P/E of 15 mean?
Simply put, a P/E of 15 would mean that the company's current market value is 15 times its annual earnings. To put it literally, if you hypothetically bought 100% of the company's shares, it would take 15 years for the company's ongoing earnings to recoup its original investment, assuming the company never grows in the future.
Why is P/E important?
The price/earnings ratio helps investors determine whether a company's stock is overvalued or undervalued relative to its earnings. The ratio is a measure of what the market is willing to pay for ongoing operations, as well as expected business growth. When a company is trading at a high price/earnings multiple, the market thinks its growth potential is high and is willing to spend more today based on future earnings.