The price-earnings ratio (P/E) is a share valuation metric commonly quoted in the financial media. The formula to calculate the P/E ratio is the company's share price divided by its earnings (or profit) per share.

For example, if a company's share price is $10 and its earnings per share last year was $1, its P/E ratio is ($10/$1) 10 times (sometimes shown as 10x). Given that the formula uses last financial year's earnings per share, this is sometimes called a trailing P/E ratio.

What is a 'forward' P/E ratio?

Sometimes, the P/E ratio is calculated using analyst forecasts for the next financial year's earnings per share.

For example, if a company's share price today is $10 and its forecast earnings per share is $1.50, the P/E ratio is ($10/$1.50) 6.6x.

Where can I find a company's earnings per share (EPS)?

Investors can find a company's earnings per share in its half-yearly or annual financial reports, at the bottom of the 'Income Statement'.

P/E ratio chart

What does the P/E tell us?

The P/E ratio gives investors an indication of how expensive a company's shares are relative to its yearly profits. A lower P/E is often perceived as being 'cheaper'.

However, it's important to remember that share prices often take into consideration the future expectations of the company, whereas the P/E ratio is taken at a point in time, kind of like a photograph.

A company's P/E ratio can also be compared to its peers. Once again, a lower P/E is seen as a positive. However, two public companies are rarely the same.

Finally, a very low price-earnings ratio can be a cause for concern. This may suggest the company is higher risk or expected to face financial difficulty.

Test Your Knowledge

China Doll Corp has a P/E of 2x. Is China Doll Corp a buy?

A price-earnings ratio is only one valuation measure. What's more, it is only a point-in-time metric, like a photograph -- and there can be a lot more going on behind the scenes!

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