The price-to-earnings ratio, or P/E, is simply a measure identifying the premium value of the company as identified by investors.
The price is what investors are willing to pay and the earnings is the financial metric reported by the company. The resulting ratio identifies the premium for the company.
Without context, it’s hard to use the P/E on its own. It’s a good metric to compare stocks in the same industry and the industry’s growth expectations (ie cloud software vs life insurance stocks).
P/E Ratio Formula
One of the simple formula when it comes to financial metrics.
P/E Ratio = P / E
- P = Price, or quote, for the stock = Market value per share
- E = EPS = Earnings per share (usually the reported annual EPS)
There are 3 potential ways to see the P/E and it’s usually classified as such but not always.
- P/E as outlined above.
- P/E (TTM) outlines the calculation uses the EPS from the trailing twelve months which could line up with the annual EPS.
- F P/E, also known as the Forward P/E, which is based on the future EPS as estimated by the company or analysts.
How Dividend Earner Uses The P/E Ratio
The way I use the P/E is to compare it with its peers. That’s usually the same companies in the industry. If there are new players vs establish players, I have to take that into account as well. A new player could have a higher P/E as a potentially faster growing company.
If one of the company has a P/E ratio out of range from its peers, then it’s worth trying to understand why that is? Is it due to an odd earning quarter? or higher expectations for future earnings.
As hinted, the P/E represents the premium an investor is willing to pay for the earnings which is essentially saying there is an expectation of future growth of a certain level.