What is the P/E Ratio?
If you're new to investing or an experienced investor, one term you should either be acquainted with or have heard of by now is the P/E (Price to Earnings) Ratio. Even though you've heard of it you still may be asking yourself: what is it? What does it mean? Why should I care?
The brief technical definition for the P/E Ratio is that it relates a company's share price to its earnings per share. Another way of looking at it is, the P/E Ratio determines how much money it could potentially cost an investor for every $1 of company profit.
Let's go through an example to help visualize how P/E is determined:
Looking at Company A, we see that they have a current share price of $50 and an EPS (earnings per share) of $2. To calculate P/E we would now take the current share price ($50) divided by the EPS ($2) to get a P/E ratio of $25.
The P/E ratio of $25 for Company A means that for every $25 invested, investors could earn $2 of profit. In other words, Company A is trading at 25 times its earnings.
Applying P/E Ratio when analyzing a stock
The P/E ratio give investors insight into how much the market is willing to pay for a slice of the profit pie, and it can help investors understand how a company stacks up against its' peers when it comes to being overvalued, undervalued, or on par.
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