Understanding Financial Statements – Price / Earnings Ratio

What is the price / earnings ratio?

The price / earnings ratio (P / E) ratio is another measure of interest to investors in public enterprises. The P / E ratio gives you an idea of ​​how much you pay at the current price per share for every dollar you earn. Earnings are the market value of the stock, not the book value of the shares outstanding on the balance sheet.

The P / E ratio is a realistic test of how high the current market price is relative to the underlying profit earned by the business. Abnormally high P / E ratios are justified only when investors feel that the company has an upside potential on earnings per share (EPS).

The P / E ratio is calculated by dividing the current market price of the stock by 12 months diluted EPS. Stock prices are increasing day by day and are subject to major changes at short notice. The current P / E ratio should be compared with the ordinary stock market P / E to determine whether the market shares are selling above or below the average.

Despite the four-year downturn in the stock market, P / E ratios are still high. P / E ratios vary from industry to industry and year to year. A mature business in a non-growth industry can only specify a market value of $ 10 per dollar, while a dynamic business in a growth industry may have a market value or net income of $ 30 per dollar of EPS.

In summary, the price / earnings ratio or P / E ratio is the current market price of a capital stock divided by its 12-month diluted earnings (EPS) or principal earnings per share if the business does not report it. Diluted EPS. Low P / E can signal an undervalued stock or an investor’s pessimistic prediction. High P / E may reveal overvalued stocks or be based on an investor’s optimistic prediction.