Price-Earnings Ratio (P/E ratio)

The ratio between the stock price and the EPS (earnings per share).  It is widely used as a valuation indicator. Essentially, the P/E ratio measures how long it will take for an investor to recoup his investment in a stock assuming the earnings do not change. A stock with a P/E of 20 would mean that the investor would get his investment back in 20 years assuming earnings do not change. However, a stock with a high P/E ratio may not be overvalued, as its earnings may be growing rapidly.

Growth stocks usually have high P/E ratios as the market expects them to continue growing strongly. The PEG (Price-earnings growth ratio) may be more useful for growth stocks. However, a stock with a 1000 P/E ratio, little earnings, and only promises of strong growth may likely be an overvalued candidate rather than a fairly valued one.

The P/E of a stock should be compared with other stocks in the same industry to gain perspective.

While the P/E of an individual stock may be of little use, the P/E of a broad market index may be a good indicator of how overvalued or undervalued the general market is, as a broad market index usually consists of large, established companies that have relatively stable earnings.

Related Terms

Popular Articles