The price / earnings ratio, also known as the P / E ratio (from the English Price / Earnings) is a tool used by investors to decide whether it is worthwhile to buy certain shares. In particular, the P / E ratio is an index that allows investors to know what is the ratio between the cost of a company share and the corporate profit that corresponds to that share. In practice, it is like knowing how many dollars you will have to pay to be able to buy 1 dollar of corporate profit. A low P / E ratio attracts investors because it means that for every dollar of profit, they will have to pay less than a dollar. At the same time, it is generally expected that companies with a high P / E ratio will see their earnings grow more than those with a low P / E ratio.
Steps
Part 1 of 2: Calculate the Ratio
Step 1. Use the formula to calculate the P / E ratio
This is simple: market value per share divided by earnings per share.
- Market value per share is simply the cost of one share of a publicly traded company. For example, on August 23, 2013, a Facebook share was listed (so it cost) 40.55 dollars.
- Earnings per share are calculated by taking a company's net income over the past four quarters, subtracting any dividends, and dividing what's left by the number of shares outstanding:
Step 2. Here is an example
Let's take an example with a real listed company: Yahoo !. On August 23, 2013, a Yahoo! it was traded at 27.99 dollars.
- We have the first part of our equation, the numerator: 27.99.
- We need to calculate the earnings per share (in English Earning Per Share = EPS) of Yahoo !. If you don't want to calculate it yourself, you can just type "Yahoo!" and "EPS" in a search engine. On August 23, 2013, the Yahoo! it was 0, 35 dollars per share.
- Divide $ 27.99 by $ 0.35. Get 79.97: Yahoo! it's about 80.
Part 2 of 2: Using the Report
Step 1. Compare the P / E ratio of different companies in the same industry
The P / E ratio by itself says nothing unless it is compared with that of other companies in the same industry. Companies with lower P / E ratios are considered "cheaper" to buy - their share price is low relative to the company's profit - although this analysis alone does not determine whether or not it is profitable to buy a company.
For example, ABC stock is trading at $ 15 per share and has a P / E ratio of 50. XYZ stock is trading at $ 85 per share and has a P / E ratio of 35. In this case, it is cheaper. buy XYZ stock, even if the stock price is higher than ABC stock. This is because with the XYZ stock, you pay $ 35 for every dollar of profit, while with the ABC title, you pay $ 50 for every $ 1 of profit
Step 2. The P / E ratio can be influenced by investors' expectations of a company's "future" value
While the P / E ratio is often considered an index of how the company has been valued in the past, it is also an index of what investors think about its future prospects. This is because stock prices mirror how much people think a stock will be worth in the future. Therefore, a high P / E ratio is a sign that investors are expecting growth in the company's earnings.
Step 3. Debt or leverage can artificially lower a company's P / E ratio
Having large debts generally increases a company's risk profile. That said, when comparing two companies with the exact same operation, in the exact same sector, the company with a moderate debt load will have a lower P / E ratio than one that has no debt. Keep this in mind when using the P / E ratio to evaluate the strength of a company.
