P/E Ratio

P/E ratio also sometimes known as "price multiple" or "earnings multiple". Companies with higher growth rates command higher P/E ratios. Confidence that a company will improve its profitability or remain profitable generally results in a higher P/E ratio. If profits are threatened or weak, the P/E ratio is likely to drop.

The P/E ratio (price-to-earnings ratio) of a stock (also called its "earnings multiple", or simply "multiple", "P/E", or "PE") is a measure of the price paid for a sharerelative to the annual income or profit earned by the firm per share. A higher P/E ratio means that investors are paying more for each unit of income. It is a valuation ratio included in other financial ratios. The reciprocal of the P/E ratio is known as the earnings yield.

P/E Ratio = Price per share / Annual Earning per share

The price per share (numerator) is the market priceof a single share of the stock. The earnings per share (denominator) is the net incomeof the company for the most recent 12 month period, divided by number of shares outstanding. Most stocks trade between a 15-25 P/E ratio. A ratio higher than 25, must have really good earnings or risk a drop in the stock price. The P/E ratio can also be calculated by dividing the company's market capitalization by its total annual earnings.

For example, if stock A is trading at $24 and the earnings per share for the most recent 12 month period is $3, then stock A has a P/E ratio of 24/3 or 8. Put another way, the purchaser of stock A is paying $8 for every dollar of earnings. Companies with losses (negative earnings) or no profit have an undefined P/E ratio (usually shown as Not applicable or "N/A"); sometimes, however, a negative P/E ratio may be shown.

By comparing price and earnings per share for a company, one can analyze the market's stock valuation of a company and its shares relative to the income the company is actually generating.[citation needed] Investors can use the P/E ratio to compare the value of stocks: if one stock has a P/E twice that of another stock, all things being equal (especially the earnings growth rate), it is a less attractive investment. Companies are rarely equal, however, and comparisons between industries, companies, and time periods may be misleading.