What is the PE Ratio?
Definition: The PE Ratio is a financial ratio to valuate for the valuation of stocks. With the PE Ratio an investor can quickly see how expensive the share-price of a company in comparison to the earnings per share is. The PE allows to compare different stocks with each other.
Calculation of the PE Ratio
current share price
earnings per share = PE Ratio
PE Calculation example: PE Apple Inc
The stock-price of Apple Inc is at US$ 590. For the current business year 2014, earnings per share of US$ 42.72 are expected.
What is the PE of Apple?
PE = 590 / 42.72 = PE 13.81
How to use the PE
PE comparison Apple vs. Samsung Electronics
A PE of 13 in our case means, that investors are currently paying 13-times the earnings of 2014 to buy an Apple stock. The Samsung stock is traded at a PE of just 7.1. You only have to pay 7-times the 2014 earnings to buy one share of the Samsung Company. That means "Samsung is cheaper valued than Apple". With the PE we can easily compare two different stocks with each other.
The lower the PE, the lower the valuation of the stock. Cheap stocks have a PE of 8-12. PEs over 15 are rather expensive.
But a high PE is often a sign of strong growth. If investors are willing to pay 20-times or 30-times the earnings, they expect the company to offer a far higher gain in the future.
A too low PE Ratio below 7 is a sign of a weak outlook and shrinking profit of that company.
The earnings per share used to calculate the PE is an assumption of the financial analysts for the current business year. These assumptions get revised on an ongoing basis and can directly influence the PE. But these assumptions are a better basis to calculate the PE, than the official earnings from last year, which is just too not up to date anymore.