Price-to-Earnings Ratio (PE)
The PE Ratio (Price-to-Earnings ratio) is a measure of the current price of a company's stock price relative to its earnings.
The PE Ratio (Price-to-Earnings ratio) is one of the most widely used fincancial ratios and allows investors to compare stocks with different earnings and dividend yields, helping them to determine the potential returns on an individual stock.
The PE Ratio can be calculated using the following formula:
PE Ratio = Share Price / Earnings per Share (EPS)
It is important to note that EPS can represent either historical or estimated values. In the latter case, it as called forward PE Ratio.
When evaluating a stock based on its PE ratio, it is important to consider market and industry averages when comparing one stock to another. On average, US stocks have traditionally had a PE ratio of around 16. However, different sectors tend to have different PE ratios and it is important to take into account the average PE ratio of the sector in which the company operates.
Benjamin Graham, famous value investor, considered a PE Ratio of 15 or lower as good but not cheap.
However a low PE ratio does not always mean the stock is undervalued. It can also mean the stock price has been down a lot and the company is facing financial woes.
The PE Ratio can be a good first hint of a company's valuation, but investors should always research the company in more detail and consider different financial metrics, signals, and market sentiment before investing in any stock.
A high PE Ratio is typically associated with a stock that is overvalued and expensive compared to other stocks in its sector. In general, if the PE Ratio is significantly higher than the industry average, it may indicate that the stock is not a good investment and investors are expecting too much from the company and are pushing up its stock price in anticipation of future growth that may not occur.
However, a higher PE Ratios do not always indicate that a stock is overvalued. For example, a high PE Ratio may be justified if the company is experiencing tremendous growth.