Price to Earnings Ratio. Ratio Review: What is a ratio? A relationship between two quantities, normally expressed as the quotient of one divided by the.

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Presentation transcript:

Price to Earnings Ratio

Ratio Review: What is a ratio? A relationship between two quantities, normally expressed as the quotient of one divided by the other: The ratio of 9 to 7 is written 9:7 or 9/7.

Stock Review Stock is ownership in a company. The price of the stock is constantly changing. Each year a company reports on how much it earns that year on a share of stock.

Price to Earnings Ratio To figure out the Price to Earnings Ratio, divide the price of a stock, by the earnings per share. Price of a stock Earnings per share

Computing P/E Ratios: 1 st we need to know the price of the stock. 2 nd we need to know the annual earnings per share. 3 rd we divide the price of the stock by the earnings.

Example: Apple (AAPL) Researching on the Internet we can find the annual earnings per share of Apple. It was $5.72 in October of Source - finance.yahoo.com The price of Apple stock changes, which means the price to earnings ratio will continually change.

Price To Earnings Ratio COMPANY SYMBOL EARNINGS PER SHARE PRICE #1 PRICE #2 PRICE #3 PRICE #4 Apple: AAPL $5.72 $78.20$115.23$145.67$ ÷ 5.72 = ÷ 5.72 = ÷ 5.72 = ÷ 5.72 =33.31

What happens to the Price to Earnings Ratios if only: The Stock Price Goes Higher? The P/E ratio goes higher. The Stock Price Goes Lower? The P/E ratio goes lower. The Earnings Go Higher? The P/E ratio goes lower. The Earnings Go Lower? The P/E ratio goes higher. What Else?

Understanding the Ratio What does a high P/E ratio mean? The stock price may be over-valued or the company is growing rapidly. What does a low P/E ratio mean? The stock price may be under-valued or the company is in a mature industry.

Understanding the Ratio Would you buy a stock with a high or low P/E ratio? “Stocks with higher forecast earnings growth will usually have a higher P/E, and those expected to have lower earnings growth will in most cases have a lower P/E.” “Investors can use the P/E ratio to compare the value of stocks: if one stock has a P/E twice that of another stock, all things being equal (especially the earnings growth rate), it is a less attractive investment. Companies are rarely equal, however, and comparisons between industries, companies, and time periods may be misleading.” – Source