Loading the player...
A:

The price-earnings ratio (P/E ratio) is a valuation measure that compares the level of stock prices to the level of corporate profits, providing investors with a sense of a stock’s value. To calculate a company’s P/E ratio, use the following formula:

P/E ratio = price per share ÷ earnings per share (EPS)

Where EPS = earnings ÷ total shares outstanding

As long as a company has positive earnings, the P/E ratio is calculated this way (a company with no earnings, or one which is losing money, has no P/E ratio). The stock price per share is set by the demand and supply prevalent in the stock market, and the earnings per share value will vary, depending on the company’s financials and which earnings variant is used. Typically, EPS is taken from the last four quarters (trailing EPS; referred to as TTM for trailing twelve months), but it can also be taken from the estimates of earnings expected over the next four quarters (forward EPS) or some other variation.

As a result, a company will have more than one P/E ratio, and investors must be careful to compare the same P/E ratio when evaluating different stocks.

To determine the P/E ratio, investors can divide the stock price by EPS. For example, Coca-Cola Co (KO) on April 12, 2017 traded at $42.90 per share with an EPS (TTM) of $1.49, so the P/E ratio would be:

P/E ratio for Coca-Cola = Stock price ($42.90) ÷ earnings per share ($1.49) = 28.79

This essentially means that investors are willing to pay $28.79 for every dollar of earnings that KO has.

For comparison, Pepsico Inc (PEP) on the same day traded at $113.11 per share with an EPS (TTM) of $4.36 and a P/E ratio of 25.94.

The average P/E ratio for companies in the Beverage sector is about 31.11, and, historically, the average P/E ratio for the broad market is around 26.4 as of 2017. KO, therefore, has a lower P/E ratio than its sector and a higher ratio than the broad market average and PEP.

The company's P/E ratio might mean that investors will expect higher earnings growth in the future compared to its competitor, Pepsico, and the overall market. The P/E ratio is only one valuation measure, however, and investors would have to dig deeper before making any investment decisions.

RELATED FAQS
  1. What does the forward p/e indicate about a company?

    Explore the forward price to earnings ratio and learn its significance and how it compares to the traditional price to earnings ... Read Answer >>
  2. How can the price-to-earnings (P/E) ratio mislead investors?

    A low P/E ratio doesn't automatically mean a stock is undervalued, just like a high P/E ratio doesn't necessarily mean it ... Read Answer >>
  3. Stocks with high P/E ratios can be overpriced. Is a stock with a lower P/E always ...

    The short answer? No. The long answer? It depends.The price-to-earnings ratio (P/E ratio) is calculated as a stock's current ... Read Answer >>
  4. What is an alternative ratio to forward p/e?

    Discover the most commonly used alternative equity evaluation ratio to the forward P/E ratio, and the relative advantages ... Read Answer >>
  5. What does it mean if a bond has a zero coupon rate?

    Learn what the average range for the price to earnings (P/E) ratio in the electronics sector is and which factors influence ... Read Answer >>
  6. What is the average price-to-earnings ratio in the oil & gas drilling sector?

    Investing in the energy sector provides an opportunity for value investors, but it is necessary to understand metrics such ... Read Answer >>
Related Articles
  1. Investing

    Beware False Signals From The P/E Ratio

    The P/E ratio is a simple tool for evaluating a company, but no one ratio can tell the whole story.
  2. Investing

    Getting On The Right Side Of The P/E Ratio Trend

    Buying at the right time is crucial, but how do we know when that is?
  3. Investing

    How Do I Calculate the Price-Earnings Ratio?

    If Apple is trading at $108.73 per share, and its trailing twelve months' EPS is $6.45, calculate the P/E ratio as...
  4. Investing

    Differences Between Forward P/E And Trailing P/E

    The most common types of price to earnings ratios are forward P/E and trailing P/E. Find out how they differ and the advantages and drawbacks of each.
  5. Trading

    Value-Priced Stocks to Watch in 2016 (AMBC, VIPS)

    In terms of P/E and Forward P/E these stocks are trading at low valuations. Watch these technical price levels for buying opportunities in 2016.
RELATED TERMS
  1. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing ...
  2. Ratio Analysis

    A ratio analysis is a quantitative analysis of information contained ...
  3. Earnings Yield

    The earnings per share for the most recent 12-month period divided ...
  4. Current Ratio

    The current ratio is a liquidity ratio measuring a company's ...
  5. Rule Of 18

    A rule whereby the sum of the inflation rate and the P/E ratio ...
  6. Franchise Factor

    The measurement of the impact on a company's price-earnings (P/E) ...
Hot Definitions
  1. Return on Market Value of Equity - ROME

    Return on market value of equity (ROME) is a comparative measure typically used by analysts to identify companies that generate ...
  2. Majority Shareholder

    A person or entity that owns more than 50% of a company's outstanding shares. The majority shareholder is often the founder ...
  3. Competitive Advantage

    An advantage that a firm has over its competitors, allowing it to generate greater sales or margins and/or retain more customers ...
  4. Mutual Fund

    An investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities ...
  5. Wash-Sale Rule

    An Internal Revenue Service (IRS) rule that prohibits a taxpayer from claiming a loss on the sale or trade of a security ...
  6. Porter Diamond

    A model that attempts to explain the competitive advantage some nations or groups have due to certain factors available to ...
Trading Center