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The Price / Earnings
(P/E) Ratio

After finding the price of a particular stock, usually the next number everyone looks at is the P/E ratio.

P/E is the ratio of a company's share price to its per-share earnings.

A P/E ratio of 10 means that the company has 1 of annual, per-share earnings for every 10 in share price. (Earnings by definition are after all taxes and etc.)

Price / Earnings

A company's P/E ratio is computed by dividing the current market price of one share of a company's stock by that company's per-share earnings.

A company's per-share earnings are simply the company's after-tax profit divided by number of outstanding shares.

A company that earned 5M last year, with a million shares outstanding, had earnings per share of 5. If that company's stock currently sells for 50/share, it has a P/E of 10. At this price, investors are willing to pay 10 for every 1 of last year's earnings.

P/E is traditionally computed with trailing earnings (earnings from the past 12 months), which is called trailing P/E.

Sometimesit is computed with leading earnings (earnings projected for the upcoming 12-month period), which is called a leading P/E.

For the most part, a high P/E means high projected earnings in the future.

But actually the P/E ratio doesn't tell a whole lot, but it's useful to compare the P/E ratios of other companies in the same industry, or to the market in general, or against the company's own historical P/E ratios.

Some analysts will exclude one-time gains or losses from a quarterly earnings report when computing this figure, others will include it.

Adding to the confusion is the possibility of a late earnings report from a company; computation of a trailing P/E based on incomplete data is rather tricky. (It's misleading, but that doesn't stop the brokerage houses from reporting something.)

Even worse, some methods use so-called negative earnings (i.e., losses) to compute a negative P/E, while other methods define the P/E of a loss-making company to be zero.

Worst of all, it's usually next to impossible to discover the method used to generate a particular P/E figure, chart, or report.

Price / Earnings 2

Like other indicators, P/E is best viewed over time, looking for a trend.

A company with a steadily increasing P/E is being viewed by the investors as becoming more speculative. And of course a company's P/E ratio changes every day as the stock price fluctuates.

The P/E ratio is commonly used as a tool for determining the value of a stock.

A lot can be said about this little number, but in short, companies expected to grow and have higher earnings in the future should have a higher P/E than companies in decline.

Price / Earnings (P/E) Ratio
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