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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  • Shozzer

    Excellent, for someone with my level of investment knowledge.
    One question: when you look at financial reports there is a sometimes no figure, or a dash, alongside ‘PE Ratio’. Why is this?

  • Alan Watson

    Excellent and clear presentation on PE ratios
    How about the Efficent frontier and its uses

  • John

    Very good. I think there is a market for videos like this. I hope you will consider doing more. You could even consider offering one or two free then charging for the rest! The topics are almost endless and would be very useful for Business Studies teachers in schools, recently retired people with a lump sum, and just ordinary people tryinjg to find a way in to investment. Well done.

  • Hero Investor

    That usually means the company are not making a profit, hence there is no price to earning ratio as there are no earnings.

  • L.Earner

    Well done MoneyWeek!
    What a great idea for novice private investors like me.
    I’ve bought and studied the books and gained some understanding, but, these bite size lectures are much easier to understand.
    I am sure there are many other topics that would be of interest and value to the “Small time” invester.

  • Tom O’Neill

    Excellent and fluent presentation, marred only by rather poor and hissy sound. I’d suggest a much closer mic, lower volume control on the recording balance, and a much drier (=less resonant) room or space for recording in.
    The speaker’s delivery is sometimes a little jerky in speed, and because of the reverberant acoustic I had to replay a couple of bits just to hear what he’d said. I’m sure if he had a closer mic and less reverb his uneven diction wouldn’t be a problem.

  • SimonC

    Good Job, about right in length, the P/E is one of the few ratios I do understand so looking forward to clips on those I don’t.

  • Jim

    Unfortunately my machine doesn’t allow sound – would it be within Budget to have subtitles? Poor speech wouldn’t matter so much then either. You do snippets within Money Week too along these lines but this seems a really good idea.

  • Helen Smith

    This is really great. Could we have something on how to spot companies “in trouble” to pair up with this? Or maybe 5 signs that a company is over/under valued? Always wanted to know about interest rate swaps too. Thanks very much.

  • Carlos

    Very good indeed! More of these will make understanding trading very easy! Thanks

  • Mike Parker

    Is “Earnings per Share” the same as the “Dividend per Share”? If not, what’s the difference?If they are the same, why have a different word for the same thing?? I’d have thought that it is the Dividend that you receive in cash for each share, and so you should want the Price/Dividend ratio, to give an indication of how many years it’ll take to get back the cost of the share.

  • Mark

    Nice work! More to follow i hope?

  • John

    Mike P
    Earning per share (EPS) is the amount of earnings the company has made (net profit) divided by the number of shares in issue

    The dividend payout is different – not all earnings are paid out to dividends (usually).
    PE ratio is therefore either the total market cap/total earnings, or price per share/earnings per share. They add to the same thing, save the units you are dividing by (one in total, the other per share).

  • Jim

    Interesting but, always a but, the share price, as we all know, tends to fluctuate sometimes a lot.

    Sainsbury share price has risen remarkably well over the last month.

    Conversely Dairy Crest has fallen badly for some over the last month.

    I use the Halifax research site and P/E is only shown for certain times of year. So the P/E ratio as it seems to me, is valid for past performance only.

    I suppose one way to calculate it is to compare the different share price per EPS and noticing the range or spread it covers and possibley calculating an ongoing average.

    Something I’ve yet to try as it depends on time and also if I got the inclination to go through lots of data, although spread sheets do help very well.

    Useful video though.

  • Tony Johnson

    The presenter says 14 years to get back your money, but really its to double your money as you still own the shares? I would like to see one on Earnings yield or return on capital

  • Hogwild

    Tony J
    The inverse of the PE is the Earnings Yield!

  • RB

    I’ve recently started dipping my toe into the investment world, so as a novice these videos are brilliant. Thanks!!

    Can you explain, how articles refer to future p/e ratios – for example the Moneyweek Oil article this week for Diamond Offshore Drilling states “current year p/e of 9.5, dropping to eight in 2011…”. As share prices fluctuate (esp will oil) how can this be estimated with any level of accuracy to be a worthwhile figure to make investment decisions?

  • Royal Berkshire

    Another novice here heard of P/E but stuff like this is always useful to test ideas against, thanks.

  • Tim Bennett

    Shozzer – the reported p/e ratio is sometimes left blank, or appears as a dash, where the number cannot be calculated. For example if a firm is loss making then the earnings per share figure is negative and the resulting p/e ratio meaningless.

  • Tim Bennett

    Jim – you are right. The p/e ratio is based on one year’s earnings only and these may not be representative over a typical business cycle. One way to correct this is to use an estimate of forward earnings instead. However this may be unreliable – earnings are very hard to predict for many businesses, especially in the current uncertain climate. Another option is to use an average of the last ten years’ earnings – this is the Shiller p/e. This at least smoothes out any “odd” years although the result is still a largely backward looking ratio.

  • Malcolm

    Another good video and another useful investment term learnt. Thanks.

    Can you explain about Settlement Dates, their frequency and coordinating of the activities, fees etc? You could include, or make a separate video lesson on, how and when tax is calculated and paid on these share transactions.

  • Tim Bennett

    Malcolm – good suggestion for a future video. Thanks!

  • Tim Bennett

    Malcolm – good suggestion for a future video. Thanks!

  • Rob

    I love it when he says poo.com


  • zara

    Tim – Do you know how many times I read this up and never understood it? This is excellent, please do more

  • Belinda

    Yes I found this VERY interesting and well explained. I then went on to watch the American guy who is rather too long winded, explaining about why bond prices fall when interest rates rise, however by the time he got to the end I did understand (I think !)

  • jakabean

    If anyone is looking at this strand…

    Can anyone tell me why, for example, on the key statistics sheets one studies online, the Vodaphone trailing P/E is 1,292.70
    and the forward P/E is only 0.10? Have they just messed up their maths. I’m looking at Yahoo but I have noticed this incidence on other sites. Thanks so much.