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Companies that aren’t profitable and, consequently, have no earnings—or negative earnings per share—pose a challenge when it comes to calculating their P/E. Some say there is a negative P/E, others assign a P/E of 0, while most just say the P/E doesn’t exist (N/A or not available) or is not interpretable until a company becomes profitable for purposes of comparison. The inverse of the P/E ratio is the earnings yield (which can be thought of as the E/P ratio). The earnings yield is thus defined as EPS divided by the stock price, expressed as a percentage.

This can then be compared to the return of an asset like the 30-year Treasury bond, which offers a yield of 1.28%. However, that number by itself tells us little about Microsoft’s valuation or prospects. Then there’s TripAdvisor (TRIP), which trades at $18 a share, yet has a P/E of over 20. In the example above, we can see that Mcdonald’s is poor value relative to the U.S. market from a P/E perspective, but good value relative to the US Restaurant industry.

That means there are three approaches to calculating the P/E ratio itself. Each of those three approaches tells you different things about a stock (or index). When it comes to the earnings part of the calculation, however, there are three varying approaches to the P/E ratio, each of which tell you different things about a stock. As well, earnings can be manipulated to downplay expectations or to make the numbers look better.

  1. A PE Ratio over 200 would indicate that the company’s share price is way more than its ability to generate matching profits.
  2. Earnings per share (EPS) is the amount of a company’s profit allocated to each outstanding share of a company’s common stock.
  3. Bank of America’s P/E at 19x was slightly higher than the S&P 500, which over time trades at about 15x trailing earnings.
  4. A stock should be compared to other stocks in its sector or industry group to determine whether it’s overvalued or undervalued.
  5. It also does not consider vital information such as the dividend yield, the level of debt at a company, management changes, and a host of other issues.

Conversely, if the price of a company’s stock is low and their earnings are high, you might have found a stock that’s on sale. In this case, the P/E ratio may suggest that the stock is undervalued, and you might be able to buy it now at a bargain. It’s good because the stock is trading at a very cheap valuation, just 5x EPS.

Example: Using a PE Ratio to Compare Facebook, Apple, Amazon, Netflix & Google

At that point, if XYZ is still trading at a P/E multiple of 10x, the share price will be worth $40, a 300% gain. This metric should be used in a comparative capacity, relative to its peers, the market as a whole, its own historical trading, and its growth and (most importantly) projected growth. If stock ABC is a utility company that provides 3G components and has no plans to innovate, its growth potential is severely limited.

Online brokerages offer stock screening tools that tell you the PE ratio of a stock, along with many other helpful data points. Andrew has always believed that average investors have so much potential to build wealth, through the power of patience, a long-term mindset, and compound interest. This is especially true with sell-side analysts, who often change their estimates frequently as a stock performs better or worse than expected. Their price targets are often way off the mark, and often overly optimistic, yet they are not generally held accountable for these errors.

Is It Better to Have a Higher or Lower P/E Ratio?

If 100 is the highest PE in the industry, then investors believe this company has the best profit growth potential in the future. This means the market participants are willing to buy the stock because it has excellent growth prospects. However, the trailing P/E also has its drawbacks, particularly during an economic contraction when a company’s earnings are under pressure. During this time, the earnings of a company typically decline, and as a result, the valuation may actually rise if the stock price doesn’t adjust down by the same amount. The trailing P/E ratio is found by taking the current share price of a stock and dividing it by the company’s reported EPS for the last 12 months (also referred to as trailing 12 month earnings).

The payout ratio could also be calculated by merely dividing the DPS ($2.87) by the EPS ($3.66) for the past year. A P/E ratio helps you compare the price of a company’s stock to the same company’s earnings. By making this comparison, you can theoretically evaluate how expensive a stock is. In this instance, the stock price may stay the same while the company’s earnings increase, which would send the PE ratio lower. Investors may see this as an opportunity to buy the stock with the expectation that the price will rise in the future to reflect the underlying earnings increase, a strategy that aligns with value investing.

The price-to-earnings ratio (P/E) is one of the most widely used tools that investors and analysts use to determine a stock’s valuation. The P/E ratio is one indicator of whether a stock is overvalued or undervalued. Also, a company’s P/E can be benchmarked against other stocks in the same industry or the S&P 500 Index. A company with a current P/E ratio of 25, which is above the S&P average, trades at 25 times its earnings. The high multiple indicates that investors expect higher growth from the company compared to the overall market.

Best Stock Research Websites & Tools – Rating The Best Stock Market Websites In 2024

The price-to-earnings ratio (P/E ratio) is a valuation metric used by investors to get an idea of whether a stock is over- or undervalued. But understanding what is a “good” P/E ratio for a stock requires additional context. It accounts for the absolute P/E (which is based on current data) and compares it to P/E values of the past. Another direct approach could be to compare the absolute P/E with the highest P/E value of the assumed time frame. Anyone who’s been in the investment market long enough will be aware of the many valuation tools that are used.

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Our work has been directly cited by organizations including Entrepreneur, Business Insider, Investopedia, Forbes, CNBC, and many others. Our goal is to deliver the most understandable and comprehensive explanations of financial topics using simple writing complemented by helpful graphics and animation videos. Our team of reviewers are established professionals with decades of experience in areas of personal finance and hold many advanced degrees and certifications. At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content.

This article contains general educational content only and does not take into account your personal financial situation. Before investing, your individual circumstances should be considered, and you may need to seek independent financial advice. Now, let’s also say Company A has a competitor who is also a bank, Company B. Company B’s stock also trades at $80 per share, but its EPS is much lower, at $5. IG International Limited is licensed to conduct investment business and digital asset business by the Bermuda Monetary Authority. Our January report reveals the 3 «Strong Buy» stocks that market-beating analysts predict will outperform over the next year. So head to WallStreetZen and start interpreting the P/E ratios of your favorite stocks.

She’s been featured in Yahoo! Finance, MarketWatch, U.S. News and World Report, Kiplinger and has written for publications like Business Insider, Credit Karma, Inc., and many others. In her spare time, she manages her own investment portfolios for herself, husband, and two kids. Aja double majored in Spanish and Economics and holds a Bachelor of Arts degree from University of Illinois at Urbana-Champaign. The relative P/E will have a value below 100% if the current P/E is lower than the past value (whether the past high or low). If the relative P/E measure is 100% or more, this tells investors that the current P/E has reached or surpassed the past value.

An industry P/E ratio is the average P/E ratio of all companies in a specific industry. For example, the industry P/E ratio for the financial services sector would include the average P/E ratio of Wells Fargo, Bank of America, JPMorgan Chase, and other related stocks. In interactive brokers other words, Bank of America traded at roughly 19x trailing earnings. However, the 18.92 P/E multiple by itself isn’t helpful unless you have something to compare it with, such as the stock’s industry group, a benchmark index, or Bank of America’s historical P/E range.

You’ve heard of the PEG Ratio, which is another measurement tool that’s related to the P/E ratio. That means it shows a stock or index’s price-to-earnings (P/E) ratio divided by the growth rate of its earnings for a specified time period. A higher P/E ratio means you are paying more to purchase a share of the company’s earnings.

A P/E ratio of N/A means the ratio is not available or not applicable for that company’s stock. However, there are inherent problems with the forward P/E metric—namely, companies could underestimate earnings in order to beat the estimated P/E when the next quarter’s earnings are announced. Other companies may overstate the estimate and later adjust it going into their next earnings announcement. Furthermore, external analysts may also provide estimates, which may diverge from the company estimates, creating confusion. The most common use of the P/E ratio is to gauge the valuation of a stock or index. The higher the ratio, the more expensive a stock is relative to its earnings.