Price-earnings ratio (P/E)

The formula

• P/E = P / EPS

P is the share price and EPS the earnings per share, the year’s net income divided by the number of shares. The ratio is a price in years: how many years of today’s profit the buyer pays for one share.

A worked example

A share at 150 with earnings per share of 10: P/E = 150 / 10 = 15. The buyer pays fifteen years of the current profit. Turned round, a company earning 10 a share that the market prices at a P/E of 20 trades at 200, and a share at 150 on a P/E of 15 is earning 10.

Reading the number

A high P/E says the market expects the profit to grow, or that the profit is temporarily low; a low one that the market expects it to shrink, or is uninterested. On its own the ratio ranks nothing: a P/E of 15 is dear for a company whose profit is falling and cheap for one whose profit doubles every few years. The PEG ratio divides the P/E by the expected growth to put that in the number.

Trailing and forward

A trailing P/E uses the last twelve months’ earnings, a forward P/E next year’s forecast. The forward figure is lower for a growing company and rests on an estimate; a quoted P/E should say which it is.

Common mistakes

• Dividing by the dividend. That gives the inverse of the dividend yield, a different measure.
• Using a loss year. With negative earnings the ratio is negative and means nothing, which is why the card requires EPS above 0.
• Comparing across industries. Utilities and software companies trade on different multiples as a matter of course.

Frequently asked questions