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 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 >>
  4. 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 >>
  5. 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 >>
Related Articles
  1. Investing

    Is Stock With a Lower P/E Always A Better Choice?

    Is a stock with a lower P/E always a better investment than a stock with a higher one? The short answer is no, but it depends on a few things.
  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

    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.
  4. 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?
  5. Investing

    Explaining Forward Price-to-Earnings Ratio

    The estimated P/E of a company is often used to compare current earnings to estimated future earnings.
RELATED TERMS
  1. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing ...
  2. Rule Of 18

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

    A term that measures some aspect of a company's financial well-being, ...
  4. Earnings Yield

    The earnings per share for the most recent 12-month period divided ...
  5. Ratio Analysis

    A ratio analysis is a quantitative analysis of information contained ...
  6. Franchise Factor

    The measurement of the impact on a company's price-earnings (P/E) ...
Hot Definitions
  1. Fiat Money

    Currency that a government has declared to be legal tender, but is not backed by a physical commodity. The value of fiat ...
  2. Investing

    The act of committing money or capital to an endeavor with the expectation of obtaining an additional income or profit.
  3. Stagflation

    A condition of slow economic growth and relatively high unemployment - a time of stagnation - accompanied by a rise in prices, ...
  4. Notional Value

    The total value of a leveraged position's assets. This term is commonly used in the options, futures and currency markets ...
  5. Interest Expense

    The cost incurred by an entity for borrowed funds. Interest expense is a non-operating expense shown on the income statement. ...
  6. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
Trading Center