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 stockâ€™s value. To calculate a companyâ€™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 stock market, and the earnings per share value will vary, depending on the companyâ€™s financials and which earnings variant is used. Typically, EPS is taken from the last four quarters (trailing P/E; 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 P/E) 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 June 18, 2014 traded at \$41.56 per share with an EPS (TTM) of \$1.87, so the P/E ratio would be:

• Stock price (\$41.56) / earnings per share (\$1.87) = 22.22

This essentially means that investors are willing to pay \$22.22 for every dollar of earnings that KO has. For comparison, Pepsico Inc (PEP) on the same day traded at \$88.90 per share with an EPS (TTM) of \$4.43 and a P/E ratio of 20.31. The average P/E ratio for companies in the Beverage sector is about 20.26, and, historically, the average P/E ratio for the broad market has been around 15. KO, therefore, has a higher P/E ratio than both the sector and broad market average, as well one of its competitors, PEP. This higher P/E ratio might mean that investors will expect higher earnings growth in the future compared to 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.

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