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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.

Video tutorial - why profit margins matter

Why profit margins are really useful

In this video, Ed Bowsher explains how to calculate a company’s profit margin, why it is the best way to evaluate profitability, and how you can use it when analysing a company.

Shale gas 'fracking' promises to transform Britain's energy market. Find out what it is, what it means, and how to invest.
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MoneyWeek Videos is our free weekly video email which breaks down the complicated world of finance and helps you understand what's really going on. Every week, MoneyWeek's Ed Bowsher takes a key piece of financial news or jargon and explains it. To join MoneyWeek Videos for free, just enter your email address.

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  • Pinkers Post

    No. It’s in terminal decline. It was revealed, today, that Aldi is now catching up with Waitrose. This is not a surprise. Aldi has moved upmarket but at the same time retaining its ‘discount’ format – very clever.

    As for Tesco, a lost cause: Suffering from a serious identity crisis, only a few days ago Tesco added ‘property developer’ to its ever expanding portfolio. Nobody knows what this company stands for or, indeed, what it IS! Supermarket? Restaurant (Giraffe!)?, coffee shop chain (Harris & Hoole)?, tech retailer (Huddle), insurance company?, bank? and so the list goes on… Clarke clearly didn’t get it: the old-style Leahy conglomerate is not the future, it’s history. Retail analysts pressing for a price war, too, don’t seem to get the message. Slashing prices and reducing profit margins is not the answer; it will only provide a short-term blip in the landscape. Radical action is needed: Break it up! And Clarke clearly was not up to the job. He was panicking, pursuing a ‘strategy’ which is well past its USE-BY (as opposed to SELL-BY) date. To top it all, Cantor recently upgraded Tesco from SELL to BUY, arguing it is now undervalued. Tesco is not undervalued. If anything, it’s overvalued. Ignore it at your peril, but a stock is cheap for a reason. And it could become cheaper still… only to turn out to be very expensive, indeed! Entry ‘Cleared OUT!’ 21 July 2014 (pls scroll down):

  • fandangle

    What really worries me is when I read that 75% of Tesco branches are outside the UK but 75% of profits come from the UK. This suggests to me that Tesco have been short changing the UK consumer for a long time while at the same time making a mess of their overseas investments. Vulnerable then on two counts. I’m staying well away !

  • dibahl

    Nice video.Would it be possible for you to post some videos on how different sector like banking, insurance, oil etc. works and what an investor should look for in these companies?

    Also a video on what companies spin off?