Price to earnings ratio

A price to earnings ratio, or price/earnings ratio, often expressed as a P/E ratio, is a standard fundamental metric used to value stocks. It is defined as the last closing share price divided by the earnings per share based on the trailing 4 quarters of earnings.

The most common version uses net income for the last four quarters available, divided by the weighted average number of common shares in issue during the period.

As an example, if stock A is trading at $24 and the earnings per share for the past year (previous 4 quarters) is $3, then stock A has a P/E ratio of 24/3 or 8. Put another way, the purchaser of the stock is paying $8 for every dollar of earnings.

P/E ratio is useful for comparing valuation of peer companies in similar sector or group. Different industries have different average P/E values, or 'multiple'. Value stocks tend to have low multiples, and growth stocks high ones.

The P/E of a company share is the result of the collective perception of the market as to how risky the company is and what its earnings growth prospects are in relation to that of other companies.

P/E can also be calculated for a stock market index, and gives an idea whether the market is cheap or expensive, although P/E depends on a number of factors.

The earnings yield is the reciprocal of the P/E ratio.