Price to earnings
Price to earnings is a ratio that divides a company stock’s current price by its earnings per share to determine the company’s relative valuation.
- The price to earnings ratio is the most popular company stock analysis by which investors evaluate a company’s relative value
- By dividing a company stock’s current price by its earnings per share, investors can use price to earnings to determine if a stock is undervalued or overvalued
- Price to earnings also serves as a comparison point for a stock against other stocks either in the same industry or the broader market
What is price to earnings?
Price to earnings is a ratio used as an analysis by investors to determine a stock’s relative value. The ratio divides a company stock’s current price by its earnings per share to establish a value that can be used to assess whether a stock is undervalued or overvalued at its current price. Investors can use this information to gauge the right timing to invest in a stock of interest.
A way of looking at price to earnings is to see it as a means of standardising the value of $1 of earnings in the market. This is because the ratio indicates the amount in dollars that an investor can expect to invest into a stock, in order to gain $1 of that company’s earnings. A high ratio would indicate that a stock is overpriced as investors are willing to pay over $1 for $1 of earnings, whereas a low ratio would indicate that a stock is underpriced as investors are willing to pay lower than $1 for $1 of earnings.
A stock can also be compared against other stocks in the same industry and/or the broader market using the value derived from its price to earnings. This information enables productive insight. Investors can use this information to determine if they should buy the stock or consider the company’s competitors in the industry and/or market instead.
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