Question

Identify and elaborate Price earnings (P:E) ratio and provide one example.

Answer 1

P:E ratio or Price to Earnings ratio can be expressed as below;

P/E= Share price/Earnings per share (or) Market value/net income

--- It is an important ratio for valuing a company and to understand the public perception of the company and its growth potential. It shows that how many times a company's stock is trading compared to the earnings it generates.

It can be used for horizontal and vertical comparisons, ie comparing P/E ratio of similar companies in the same industries or historically comparing the variations in P/E ratio.

For example let a company ABC has 50000 outstanding shares and its share price is 80 $; Lets assume it has generated a net income of 500000 $ ;

Then P/E ratio= Price per share/EPS = 80/(500000/50000) = 8 ; ie the company is valued 8 times higher compared to the earnings it generates.