What the PE ratio is all about

Fsp Invest, 31 Oct. 2013

Tags: pe ratio, price earnings ratio, pe, what is the pe, what is the pe ratio, share ratio, investing, financial ratios

The world of investing is choked full of different financial ratios. And at first glance they can all look a bit daunting. One of the most widely used ratios you’ll come across is the price earnings (PE) ratio. Analysts love quoting it and you’ll come across it in financial and investment publications. But what does it actually tell you? Read on to uncover what the PE ratio is all about…

This ratio is a favourite starting point for analysts, Gareth Stokes in Fear, Greed and the Stock Market explains…

In its simplest form the PE ratio is:

PE = current share price/earnings per share

You’ll come across the PE ratio in two different forms: The current PE and the forward PE.

The basis of the current PE is the current share price and the earnings for the last reporting period. If you look at a company’s financial results, you’ll find the earnings per share (EPS) value and this is the figure you use for this ratio.

Some analysts refer to this ratio as the historic PE ratio because it relates to a past accounting period.

The PE ratio in practice

Let’s say XYZ Holdings has just released its 2013 full-year results.

The company managed earnings per share of 10c. The current price of XYZ Holdings is 200c.

To calculate the current PE ratio you simply divide the price by the earnings (200c/10c). This gives you a value of 20 times.

This means if you buy XYZ at 200c, you’re prepared to pay 20 times the current earnings for the share.

If you want to know the forward PE ratio, you need to have an expected earnings number for the coming year.

If XYZ Holdings expects 2014 earnings to be double the 2013 number (or 20c) then the forward PE (this time current price over 2014 expected earnings) is a more reasonable 10 times.

This ratio is very difficult to use in isolation. You’re best to compare the PE ratios of different shares in the same sector. This gives you an idea of whether one share is cheap relative to another.

So there you have it, what the PE ratio is all about.

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