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Price-to-Earnings Ratio

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

This ratio is good for the investors who like to evaluate often as to what a stock’s fair market value should be by predicting future earnings per share. Companies that have higher future earnings are usually expected to issue higher dividends or have appreciating stock in the future.

Formula to calculate Price Earnings Ratio

The formula to calculate Price Earnings Ratio is:

Price Earning Ratio = Market Value Price per Share / Earnings per Share

Analysis

The price to earnings ratio shows the expected price of a share based on its earnings. As a company’s earnings per share rise, so does their market value per share. A company having a high P/E ratio usually indicated positive future performance and investors are willing to pay more for this company’s shares.

A company having a lower ratio is a clear indication of poor current and future performance. This could prove to be a poor investment and investors might lose their interest in the company.

Example

A company named Vovno has its stock price closed at $91.09. The company’s profit for the fiscal year ending January 31, 2017, was $13.64 billion, and its number of shares outstanding was 3.1 billion. Its EPS can be calculated as:

$13.64 billion / 3.1 billion = $4.40

Vovno’s P/E ratio is, therefore, $91.09/$4.40 = 20.70x

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