P/E is an acronym which is used to refer to a stock's price-earnings ratio, and is a valuation measure that describes the relative expense of a stock with respect to its earnings per share. Earnings per share must first be quantified in order calculate P/E.
Earnings Per Share
Earnings per share (EPS) is the total net earnings of a company divided by the total number of shares outstanding. For example, a company has earned $1.7 billion dollars over the past year and has 170 million shares out. It has a trailing annual EPS of $10.
Price-Earnings
P/E is determined by dividing a stocks price by the EPS for the past 12-month period. If a stock has a share price of $95 and EPS of $10, its price-earnings ratio is 9.5, or 9.5 times earnings. P/E can also be calculated on estimated future earnings.
Significance
Identifying the price-earnings ratio permits investors to better understand the price paid for a company's earnings. Stocks with a high P/E are considered more expensive and low P/E stocks are less expensive relative to their earnings.
Variances
Stocks typically have high P/Es when a company’s EPS growth rate is high and investors are willing to pay more (relative to earnings prospects) for its stock. Low P/E ratios are associated with companies that have lower--or slower--earnings growth rates and attract less interest from investors.
Sector Characteristics
P/E is a useful tool in determining relative share value of a company's stock. However, on its own, it can be a misleading indicator. It's important to evaluate it compared to other companies in that group as well as in relation to the EPS trends of the company and group in the future.
