## What is the 'Price-Earnings Ratio - P/E Ratio'

The price-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings. The price-earnings ratio is also sometimes known as the price multiple or the earnings multiple.

The P/E ratio can be calculated as: Market Value per Share / Earnings per Share

Next Up

## BREAKING DOWN 'Price-Earnings Ratio - P/E Ratio'

In essence, the price-earnings ratio indicates the dollar amount an investor can expect to invest in a company in order to receive one dollar of that company’s earnings. This is why the P/E is sometimes referred to as the price multiple because it shows how much investors are willing to pay per dollar of earnings. If a company were currently trading at a multiple (P/E) of 20, the interpretation is that an investor is willing to pay \$20 for \$1 of current earnings.

[ Price-earnings ratios are the most popular way to assign a relative value to a stock, but there are many other techniques that investors use to make decisions. If you're interested in learning more about investing, Investopedia's Investing for Beginners Course provides an in-depth introduction to the topic guided by a Chartered Financial Analyst. You'll learn the basics, how to manage your portfolio, techniques for reducing risk, and how to make informed decisions in over 75 lessons containing on-demand video, exercises, and interactive content. ]

To calculate the P/E ratio, the earnings per share (EPS) must be known. EPS is most often derived from the last four quarters. This form of the price-earnings ratio is called trailing P/E, which may be calculated by subtracting a company’s share value at the beginning of the 12-month period from its value at the period’s end, adjusting for stock splits if there have been any. Sometimes, price-earnings can also be taken from analysts’ estimates of earnings expected during the next four quarters. This form of price-earnings is called a projected or forward P/E. A third, less common variation uses the sum of the last two actual quarters and the estimates of the next two quarters.

Let's calculate the P/E ratio for Wal-Mart Stores Inc. (NYSE:WMT), as of November 14, 2017 when the company's stock price closed at \$91.09. The company's profit for the fiscal year ended January 31, 2017 was \$13.64 billion and its number of shares outstanding is 3.1 billion. Its EPS can be calculated as \$13.64 billion / 3.1 billion = \$4.40. Wal-Mart's P/E ratio is, therefore, \$91.09/\$4.40 = 20.70.

You can track the P/E ratios for the stocks in your portfolio or individual stocks by adding them to your own 'Watchlist'. Here we list the top and bottom three companies in the S&P 500 by P/E ratio. This list updates daily based upon movements in the stock prices, so adding stocks you are interested in to your Watchlist is the best way to keep an eye on them.

## Investor Expectations

In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E. A low P/E can indicate either that a company may currently be undervalued or that the company is doing exceptionally well relative to its past trends. When a company has no earnings or is posting losses, in both cases P/E will be expressed as “N/A.” Though it is possible to calculate a negative P/E, this is not the common convention.

The price-earnings ratio can also be seen as a means of standardizing the value of one dollar of earnings throughout the stock market. In theory, by taking the median of P/E ratios over a period of several years, one could formulate something of a standardized P/E ratio, which could then be seen as a benchmark and used to indicate whether or not a stock is worth buying.

## Limitations of 'Price-Earnings Ratio - P/E Ratio'

Like any other fundamental designed to inform investors as to whether or not a stock is worth buying, the price-earnings ratio comes with a few important limitations that are important to take into account, as investors may often be led to believe that there is one single metric that will provide complete insight into an investment decision, which is virtually never the case.

One primary limitation of using P/E ratios emerges when comparing P/E ratios of different companies. Valuations and growth rates of companies may often vary wildly between sectors due both to the differing ways companies earn money and to the differing timelines during which companies earn that money. As such, one should only use P/E as a comparative tool when considering companies within the same sector, as this kind of comparison is the only kind that will yield productive insight. Comparing the P/E ratios of a telecommunications company and an energy company, for example, may lead one to believe that one is clearly the superior investment, but this is not a reliable assumption.

An individual company’s P/E ratio is much more meaningful when taken alongside P/E ratios of other companies within the same sector. For example, an energy company may have a high P/E ratio, but this may reflect a trend within the sector rather than one merely within the individual company. An individual company’s high P/E ratio, for example, would be less cause for concern when the entire sector has high P/E ratios.

Moreover, because a company’s debt can affect both the prices of shares and the company’s earnings, leverage can skew P/E ratios as well. For example, suppose there are two similar companies that differ primarily in the amount of debt they take on. The one with more debt will likely have a lower P/E value than the one with less debt. However, if business is good, the one with more debt stands to see higher earnings because of the risks it has taken.

Another important limitation of price-earnings ratios is one that lies within the formula for calculating P/E itself. Accurate and unbiased presentations of P/E ratios rely on accurate inputs of the market value of shares and of accurate earnings per share estimates. While the market determines the value of shares and, as such, that information is available from a wide variety of reliable sources, this is less so for earnings, which are often reported by companies themselves and thus are more easily manipulated. Since earnings are an important input in calculating P/E, adjusting them can affect P/E as well.

## Things to Remember

• Generally a high P/E ratio means that investors are anticipating higher growth in the future.
• The average market P/E ratio is 20-25 times earnings.
• The P/E ratio can use estimated earnings to get the forward looking P/E ratio.
• Companies that are losing money do not have a P/E ratio.
• You can expand your financial vocabulary by subscribing to our Term of the Day newsletter.
RELATED TERMS
1. ### P/E 30 Ratio

P/E 30 ratio means that a company's stock price is trading at ...
2. ### Forward Price To Earnings - Forward ...

Forward price to earnings (forward P/E) is a measure of the price-to-earnings ...
3. ### Trailing Price-To-Earnings - Trailing ...

The sum of a company's price-to-earnings, calculated by taking ...
4. ### Price-Earnings Relative

The price-earnings relative figure is the price-earnings ratio ...
5. ### Price Multiple

A price multiple is any ratio that uses the share price of a ...
6. ### Franchise Factor

The franchise factor is the measurement of the impact on a company's ...
Related Articles
1. Investing

### How To Use The P/E Ratio And PEG To Tell A Stock's Future

The P/E ratio is used to calculate stock price valuation. However the PEG ratio includes earnings growth and can provide insight as to whether the P/E valuation is justified.
2. 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.
3. Investing

### Comparing the P/E, EPS And Earnings Yield

Here are three ratios that help investors value stock returns.
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

### 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.
RELATED FAQS
1. ### 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 >>
2. ### 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 >>
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. ### Absolute P/E Ratio Vs. Relative P/E Ratio

The difference between absolute P/E and relative P/E is easier when you know why each term is used. Read Answer >>
5. ### What is the average price-to-earnings ratio in the financial services sector?

Learn how to calculate and use the price to earnings (P/E) ratio when analyzing an investment and what the financial services ... Read Answer >>
Hot Definitions
1. ### Economies of Scale

Economies of scale refer to reduced costs per unit that arise from increased total output of a product. For example, a larger ...
2. ### Quick Ratio

The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets.
3. ### Leverage

Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
4. ### Financial Risk

Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
5. ### Enterprise Value (EV)

Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...
6. ### Relative Strength Index - RSI

Relative Strength Indicator (RSI) is a technical momentum indicator that compares the magnitude of recent gains to recent ...