An investor needs a measure to compare the price that he would be willing to pay for stocks. The investor also needs a common benchmark to measure it against. Thousands of companies are quoted on the stock exchanges. How does one go about having a common bench mark? Herein emerged the concept of price earnings ratio. Stated simply this measures how many times, an investor is willing to pay for a company' stock.
Company earnings are reported usually as EPS - an acronym for earnings per share. This is a simple calculation of dividing a company's earnings by the number of equity shares that it has issued. Let us say, Bank of America has reported earnings per share of $3.00. Next look at the market price. Assume that this share is quoted at $24. Divide $24 by $3 to arrive at a Price earnings ratio of 8. The market is willing to pay eight times the earnings per share of $3.
Note that the P/E is an absolute number. Usually companies on a high growth curve would have a higher multiple. For instance google has a P/E of 100. Investors were willing to pay 100 times its earnings per share. Why was this? The investors were confident about the growth of Google. They expected the company to grow exponentially and have high earnings per shares in a relatively short period of time. Bank of America has a P/E of 8, because investors suspect that the financial markets are not a good place to be in the current investment climate. One can also compare P/E for a company among its peers, for the industry as a whole. This can provide indicators of what the market perceives as the value for a company compared to its peers.
Understanding P/E ratio and how it is computed is key to understanding stocks and investing.
Article summary :
Understanding P/E ratio and how it is computed is key to understanding stocks and investing.
Company earnings are reported usually as EPS - an acronym for earnings per share. This is a simple calculation of dividing a company's earnings by the number of equity shares that it has issued. Let us say, Bank of America has reported earnings per share of $3.00. Next look at the market price. Assume that this share is quoted at $24. Divide $24 by $3 to arrive at a Price earnings ratio of 8. The market is willing to pay eight times the earnings per share of $3.
Note that the P/E is an absolute number. Usually companies on a high growth curve would have a higher multiple. For instance google has a P/E of 100. Investors were willing to pay 100 times its earnings per share. Why was this? The investors were confident about the growth of Google. They expected the company to grow exponentially and have high earnings per shares in a relatively short period of time. Bank of America has a P/E of 8, because investors suspect that the financial markets are not a good place to be in the current investment climate. One can also compare P/E for a company among its peers, for the industry as a whole. This can provide indicators of what the market perceives as the value for a company compared to its peers.
Understanding P/E ratio and how it is computed is key to understanding stocks and investing.
Article summary :
Understanding P/E ratio and how it is computed is key to understanding stocks and investing.