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A beginner’s guide to p/e ratios

MoneyWeek deputy editor Tim Bennett explains one of the most widely used ratios you’ll see in the financial media – the price/earnings, or p/e ratio. What it measures, how you calculate it, and what it’s used for.

• See also: What is ‘earnings per share’?

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P/e ratio

The price/earnings ratio is a quick way to establish a firm’s relative value. You get it by either dividing a firm’s market capitalisation by its profits after tax, or by dividing the price of one share by the firm’s earnings per share. The p/e tells you how many years it will take the firm to make profits equivalent to its market cap: if the p/e is ten, assuming profits stay the same, it will take ten years. A high p/e, or ‘multiple’, suggests a firm that is growing or is expected to grow fast. A high-growth firm with a low p/e could be considered cheap, and a low-growth firm with a high p/e could be considered expensive. The p/e is the main measure analysts use to determine a company’s position relative to the rest of the market.

• Entry from MoneyWeek’s Financial glossary.

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2 Responses

  1. 01/09/2014, RTag wrote

    Government fudging figures to help make things look better than they are?? Gosh, that’s a new development!! ;)
    Interesting video; I have two comments on it:
    1) One way of looking at this is that the Treasury is effectively reneging on its promise to pay the interest on the Gilts that APF is purchasing – albeit via some other back door mechanism – but doesn’t this ultimately carry some risk of devaluing (confidence in) the value of UK paper beyond what was intentioned by the original purchasing mechanism?
    2) I see where you’re coming from regarding keeping the £35bn profit within the APF as a hedge against future price fluctuations, but as the Bank of England is simply willing the money into existence in the first place, surely it’s a bit of a moot point (on the basis that, should the APF ultimately start getting into the red, BoE can simply print some more money to prop them up??)
    At some stage, it’s all going to end in tears…

  2. 01/09/2014, RTag wrote

    Apologies – the above comments were meant for Tim’s video on the Chancellor nicking £35bn from the Bank of England; don’t know how I ended up here!!

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