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’?
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.