P/E Ratio

The price/earnings ratio gives an indication of what shareholders are paying for continuing earnings per share. Investors view it as an indication of what the market considers to be the firm’s future earning power.

A company’s P/E Ratio is greatly influenced by whether the company is in a high-growth stage or a lowgrowth stage. A company in a high-growth stage will usually have a high P/E ratio because of the market’s expectations of future profits (which makes the market price higher) despite the fact that at the current time, profits may be low. Companies in a low-growth stage generally have lower P/E ratios.

If the Basic EPS used in the P/E ratio covers a period of less than one year, it should be annualized. For example, multiply a quarterly basic earnings per share figure by four.

A company’s P/E ratio can be interpreted by comparing it with the average P/E ratio for the industry and with all stocks on an exchange.

The P/E ratio is not meaningful when a company is experiencing losses because the P/E would be negative since earnings are negative.

If a company’s managers are manipulating its reported income, the company’s P/E ratio will be affected, since the P/E ratio is based on net income.