What Is the Price-to-Earnings Ratio?

The price-to-earnings (P/E) ratio, sometimes referred to as the "multiple," measures a company's share price compared to its earnings per share (EPS). The P/E is commonly used in fundamental analysis as a valuation metric. Analysts and fundamental investors use it to determine whether a company's stock price is appropriate compared to the earnings per share (EPS) generated by the company.

If a company has a high P/E ratio, investors are willing to pay a premium price for its stock compared to its earnings. For example, ABC company has a P/E ratio of 12. Therefore, an investor is willing to pay $12 for every dollar of earnings. A ratio of 2 means that an investor is willing to pay $2 for every dollar of company earnings.

Generally, high P/E ratios indicate that a company's stock is overvalued, whereas low P/E ratios indicate that a company's stock is undervalued. The P/E ratio alone does not provide a holistic view of the value of a company's stock. This ratio along with other metrics and research can enable investors to make sound, educated decisions about a company's stock value.

Key Takeaways

  • The price-to-earnings (P/E) ratio is a valuation metric that measures a firm's stock price relative to its earnings.
  • Investors review the P/E ratio to determine if a company's stock price is undervalued or overvalued.
  • The P/E ratio indicates the price an investor is willing to pay per dollar of a company's earnings.
  • The trailing P/E ratio for the retail industry in January 2021 was 22.70.

Understanding the Retail Sector's Average P/E Ratio

The NYU's Stern School of Business publishes P/E data for different industries, including the retail industry. The retail sector is divided into seven categories: automotive, building supply, distributors, general, grocery and food, online, and specialty lines retail companies.

According to NYU's Stern School, as of January 2021 and using trailing 12-month data, the average P/E ratio of the retail sector is 22.70. This value ranges from a low of 14.41, which is the average of grocery and food retailers, to a high of 140.11, which is the average of building supply retailers.

Different industries may calculate their earnings differently and at different times, and so comparing P/E ratios for companies in different industries may not be suitable.

In January 2021, building supply retail companies have an average P/E ratio of 140.11, general retail companies have an average of 22.70, grocery and food retail companies have an average of 14.41, retail distributors have an average of 138.44, and specialty lines retail companies have an average P/E ratio of 55.99.

The average P/E ratio of the retail sector is calculated using the arithmetic mean average. The retail sector's P/E ratio is calculated as (11.74 + 27.48 + 18.93 + 18.48 + 12.67 + 38.96 + 15.49) / 7. This average includes large-cap stocks, such as Walmart, Costco Wholesale Corporation, Dollar Tree Incorporated, and Home Depot.