10 Second Take:
Price-to-earnings — or P/E — shows you what investors are willing to pay per share for each $1 of a company’s earnings.
What it means:
A price-to-earnings ratio is a tool to measure a listed company’s share price relative to its earnings per share (EPS). Because this ratio standardizes the relationship between share price and earnings, it can help investors identify the value of potential investments and meaningfully compare companies with vastly different share prices. P/E ratios are typically used to study companies in the same industry or a single company over a specific time horizon.
To find the P/E ratio of a listed company, take the current price of a stock and divide it by the earnings per share (EPS). Here’s an example: If a company’s stock price is $10 and the earnings per share are $2, the P/E ratio would be 5 (10/2 = 5). An analyst or investor would describe this as “5 times earnings.” In other words, at $10 you would be paying five times the value of the EPS. With that information, you can compare the ratio to another company. Company A might trade at a P/E of five times, for example, while company B trades at eight times.
This ratio can flag an opportunity to look more closely at the performance of the company: Are there factors that merit a higher P/E? A high P/E could mean a stock is expensive relative to its earnings, for example. Purchasing a stock with a high ratio isn’t necessarily a bad thing — the P/E could be higher because markets see growth potential. Alternately, a low P/E may indicate the market anticipates slower growth for the company. Either way, it can be an opportunity to do more research on a potential investment.