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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.

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