A:

When it comes to valuing stocks, the price-to-earnings (P/E) ratio is one of the oldest and most frequently used metrics. It is calculated by taking a company's share price and dividing this by its earnings per share. This provides a measure of the price being paid for the earnings - the higher the P/E, the more expensive the earnings. However, a company's standalone P/E doesn't give us a full picture of how expensive a stock is unless we look at it relative to the company's industry or a broad market index such as the S&P 500 and the Dow Jones Industrial Average (DJIA).

You can find an industry's P/E by analyzing industry statistics through finance websites such as Yahoo! Finance. If your company's P/E differs greatly from the industry's, you should investigate why there is a difference. If a company's P/E is twice as large as the industry's, this means investors should proceed cautiously, because no company can grow faster than the overall industry forever.

The P/E of an index - the total price of the index divided by its total earnings - is a little more difficult to come upon. Many financial websites have P/Es for individual companies, but not for indexes like the DJIA or S&P 500. To get this information, you have to go straight to the source - the index's publishers. For example, you can find the P/E for the S&P 500 on the Standard & Poor's website and for the DJIA on the Dow Jones website.

Another way to get an estimate of the P/E ratio is to look at the P/E ratio of an exchange-traded fund (ETF), which closely follows the index in question. While this measure is not as exact as the index's own measure, the information is a lot easier to find. For example, the P/E for the Wilshire 5000 can be obtained through VIPERS or the Nasdaq 100. This will work with the DJIA and the S&P 500 as well.

etf.gif

Again, the P/E found on an ETF will not be exactly the same as the P/E of the index. This discrepancy is due to the fees charged on an ETF, along with the fact that ETFs are traded on the stock market. Fluctuations in the price of the ETF are affected by both the underlying index and the regular price movement of the ETF, which acts like a stock. However, the return on an ETF is often very close to the index's return.

(For further reading, see Understanding the P/E Ratio and Introduction To Exchange-Traded Funds.)

RELATED FAQS
  1. How can I find the P/E ratio on an ETF's underlying index?

    Learn how analysts and investors can determine the price-to-earnings ratio for the underlying index of an exchange-traded ... Read Answer >>
  2. What's the difference between absolute P/E ratio and relative P/E ratio?

    The simple answer to this question is that absolute P/E, which is the most quoted of the two ratios, is the price of a stock ... Read Answer >>
  3. What is the difference between forward p/e and trailing p/e?

    Understand the difference between the trailing P/E ratio, which is the standard price-to-earnings calculation, and the forward ... Read Answer >>
  4. 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 >>
  5. 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 >>
  6. What is the average price-to-earnings ratio in the banking sector?

    Explore the price/earnings ratio in regard to the banking industry and learn what the average P/E ratio is for most banking ... Read Answer >>
Related Articles
  1. 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.
  2. 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.
  3. Investing

    Comparing the P/E, EPS And Earnings Yield

    Here are three ratios that help investors value stock returns.
  4. Investing

    Can Investors Trust The P/E Ratio?

    The P/E ratio is one of the most popular stock market ratios, but it has some serious flaws that investors should know about.
  5. 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?
RELATED TERMS
  1. Forward Price To Earnings - Forward P/E

    A measure of the price-to-earnings ratio (P/E) using forecasted ...
  2. P/E 30 Ratio

    The price-to-earnings (P/E) ratio is the valuation ratio of a ...
  3. Trailing Price-To-Earnings - Trailing P/E

    The sum of a company's price-to-earnings, calculated by taking ...
  4. Franchise P/E

    The expected value of new business opportunities available to ...
  5. Rule Of 18

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

    A term that measures some aspect of a company's financial well-being, ...
Hot Definitions
  1. Tender Offer

    An offer to purchase some or all of shareholders' shares in a corporation. The price offered is usually at a premium to the ...
  2. Ponzi Scheme

    A fraudulent investing scam promising high rates of return with little risk to investors. The Ponzi scheme generates returns ...
  3. Dow Jones Industrial Average - DJIA

    The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange ...
  4. Revolving Credit

    A line of credit where the customer pays a commitment fee and is then allowed to use the funds when they are needed. It is ...
  5. Marginal Utility

    The additional satisfaction a consumer gains from consuming one more unit of a good or service. Marginal utility is an important ...
  6. Contango

    A situation where the futures price of a commodity is above the expected future spot price. Contango refers to a situation ...
Trading Center