The price earning ratio (P/E ratio) is a financial calculation that compares a stocks current share price to the earnings per share. One of the most widely used financial ratios in the stock market, the P/E can help investors understand the value of a company. It can also be used to compare different stocks with one another as well as predict the future value of a company. While not perfect, the price earning ratio is an important tool for investors to use to make investment decisions.
Price Earning Ratio Calculation
The P/E ratio calculation can be calculated using the following formula.
Price Earning = Current Share Price / Earnings per Share
If a company currently trades at $50 per share with annual earnings (over the last 12 months) equal to $2.00, then the P/E ratio is equal to 25 ($50 / $2.00). Note that that earnings per share is normally calculated using the last four quarters results. Another term used by investors for this equations is the trailing P/E.
Another version of the price earning ratio is referred to as the future P/E. As the name states, this calculation uses future earnings projections made by analysts covering the the company. A stock with a future earnings projection of $3.00 that is currently trading at $50 would have a future P/E equal to 16.7 ($50 / $3.00).
Financial Calculations and Ratios
Investors who don’t use important financial calculations like the price earning ratio are not doing their due diligence on an investment choice. Used in combination with other important financial data, the P/E ratio can provide a wealth of important information to an investor. Since most of these important calculations can be found on most financial websites, or even calculated directly, there is no excuse. Knowledge and education is power in the stock market, which eventually leads to gains as opposed to losses on an investment.
Understanding the important of how a price earning ratio is calculated can help put knowledge in the hands of ever investor.