Price Earnings Ratio Formula, Examples and Guide to P E Ratio

If a company’s earnings exceed expectations, the share price tends to rise, resulting in a higher P/E. But calculating, comparing, and interpreting this metric across various sources, timeframes, and scenarios provides a richer perspective for stock research. P/E ratio calculators are handy online tools investors can use to quickly assess a stock’s valuation. By simply inputting a stock ticker symbol, these calculators automatically source and compute the current P/E ratio using available data.

If a company borrows more debt, the EPS (denominator) declines from the higher interest expense. The extent of the share price impact largely depends on how the debt is used. The P/E ratio would be a significantly large multiple and not price to earnings ratio formula be comparable to industry peers (i.e. as a complete outlier) — or even come out to be a negative number.

P/E Ratio as a Tool for Stock Research

If the P/E ratio is at an extreme—as compared to its peers or the market as a whole—it’s up to the investor/trader to ascertain whether the P/E in question is appropriate. The justified price-to-earnings (P/E) ratio differs from standard P/E ratios as it aims to calculate what the P/E multiple should be based on expected future performance. Additionally, TCS enjoys operating margins of 25% versus 11% for RIL due to the high-margin nature of IT services versus the competitive dynamics in RIL’s retail and telecom segments. These accounting expenses decrease reported earnings even though they do not represent an outflow of cash. Technology companies, for example, often have high non-cash depreciation costs related to equipment and facilities.

Among the many ratios, the P/E is part of the research process for selecting stocks because we can figure out whether we are paying a fair price. For example, in February 2024, the Communications Services Select Sector Index had a P/E of 17.60, while it was 29.72 for the Technology Select Sector Index. To get a general idea of whether a particular P/E ratio is high or low, compare it to the average P/E of others in its sector, then other sectors and the market. The last alternative to consider is the enterprise value-to-EBITDA (EV/EBITDA) ratio. It assesses a company’s valuation relative to its earnings before interest, taxes, depreciation, and amortization. The EV/EBITDA ratio is helpful because it accounts for the company’s debt and cash levels, providing a more holistic view of its valuation compared to the P/E ratio.

Evaluating stocks in context is key to determining an appropriate valuation. To calculate the P/E ratio, simply divide the current stock price by the trailing 12 months earnings per share. Analysts may also use forward P/E ratios based on predicted future earnings.

P/E vs. Earnings Yield

1. The P/E ratio can help us determine, from a valuation perspective, which of the two is cheaper.
2. Companies with higher ROE and ROCE tend to have higher P/Es since they generate more profits from the capital invested in the business.
3. RIL is a diversified conglomerate involved in energy, petrochemicals, retail, telecom and other sectors.
4. Understanding both the utility and constraints of P/E analysis is key for investors.
5. Additionally, the Price Earnings Ratio can produce wonky results, as demonstrated below.

Comparing a stock’s current P/E to its historical range and industry peers’ P/Es puts the ratio into better context. Factors like market share gains, new products, network effects, switching costs and cost advantages are able to drive higher growth and justify higher P/E multiples. Weakening competitive position or disruption risks could warrant applying a lower P/E ratio. The strength of the underlying business model must align with the growth assumptions behind a higher P/E valuation. Assess what is driving the stock’s price performance – is it broad market sentiment or company-specific fundamentals?

The P/E Range: Historical vs. Current Valuations

As such, the P/E ratio does not always accurately reflect the company’s long-term earning power and growth potential. Accounting policies around areas like depreciation, inventory valuation, and R&D expenses sometimes affect earnings. Therefore, P/E ratios are, at times, not directly comparable across companies with different accounting practices. Investors must dig deeper into financial statements to adjust for these differences before comparing P/E ratios. High-growth industries like technology tend to have higher P/E ratios, around 20-30x, while slower-growing industries like financials and industrials average mid-teens P/E ratios. Comparing a stock’s P/E to its peer group provides a better gauge of relative value.

Can the P/E ratio be negative?

High-growth industries tend to have higher P/E ratios versus slow-growing or cyclical industries. Comparing P/E ratios across very different industries is sometimes not useful. Investors should compare P/E ratios among peers in the same industry group rather than broadly across the entire market.

And when it does, investors make a profit as a result of a higher stock price. Examples of low P/E stocks can be found in mature industries that pay a steady rate of dividends. Companies with a high Price Earnings Ratio are often considered to be growth stocks.

For equity investors who earn periodic investment income, this may be a secondary concern. This is why many investors may prefer value-based measures like the P/E ratio or stocks. The market price of the shares issued by a company tells you how much investors are currently willing to pay for ownership of the shares. The longer the forecast, the more a company’s earnings tend to normalize over time and converge towards the industry average, which is why multiples decline as a company matures. While the P/E ratio has limitations and should not be the sole factor in making investment decisions, it remains a useful starting point for stock analysis.

The P/E ratio gives investors an idea of how much they are paying for each rupee of a company’s earnings. TCS also has stronger 18-20% expected earnings growth versus 10-12% for RIL. Further, TCS offers stable 2.5% dividend yields, while RIL’s payouts have been inconsistent. Moreover, TCS has a debt-free balance sheet compared to RIL’s leveraged position. Finally, TCS enjoys stable, recurring revenue streams, unlike RIL’s profits, which are vulnerable to oil prices and industry cyclicality.

1. Sudden surges in valuation often revert back toward the average eventually.
2. A negative or extremely high P/E ratio typically signals problems for a company’s stock.
3. Certain unprofitable companies have no other option but to use forward P/E ratios, as a negative EPS would make the ratio meaningless.
4. Many investors would likely agree that determining the price-to-earnings (P/E) ratio is a critical but often perplexing task.
5. An investor might be comfortable buying in at a high P/E ratio, expecting earnings growth to bring the P/E back down to a lower level if the company is growing quickly.
6. To get your P/E ratio, you also need to understand how to get earnings per share.
7. A company’s earnings power and future earnings guidance from management can influence investors’ perception of its current P/E ratio.

Suppose a company’s market share price is currently $30.00 as of the latest closing date. However, forward valuation multiples are not used exclusively for unprofitable companies, as often both the trailing and forward P/E ratios are often presented side by side. The forward P/E ratio shows the relationship of a company’s price (today) to its forecasted earnings per share (EPS). In summary, while a limited metric on its own, the P/E ratio remains a useful fundamental analysis tool when applied properly and in context. Understanding both the utility and constraints of P/E analysis is key for investors. When companies announce quarterly or annual earnings, it often leads to share price and P/E adjustments.

Either way, the P/E ratio would not be meaningful or practical for comparison purposes. The two-year forward P/E comes out to 20.0x, which is more practical for performing valuation analysis and for comparisons against industry peers. The EPS in the one-year forward P/E is no longer negative, but since the company is still barely profitable, the calculated 60.0x P/E ratio is still not too useful. One distinct benefit to forward P/E ratios is that the underlying company’s financials are “normalized,” e.g. the effects of non-recurring items are removed. Certain unprofitable companies have no other option but to use forward P/E ratios, as a negative EPS would make the ratio meaningless. High-growth companies typically prioritize acquiring new customers and achieving out-sized growth at all costs, even if it means enduring an unsustainable cash burn rate.