Price to earning ratio
Or
PE , is one of a large family of
valuation ratios which are intended to help
investors make sound decisions.
The fundamental concept of PE ratios is that the
shares of
companies in the same
industry should, in the absence of easily understood reasons to the contrary, trade for roughly the same price.
Intuitively this make sense. Consider for example two
computer software services firms, with roughly identical
financial details; that is,
earnings, outstanding
debt,
sales, etc.
An astute investor, using
PE , might notice that the market was
undervaluing one firm, or perhaps
overvaluing the other.
Price to earnings can be calculated by dividing a company's
market cap by its total earnings, or else dividing its
share price by its
earnings per share (EPS).
A final but perhaps
obvious note about PE ratios; this is a meaningless concept for firms without earnings.
In this case investors must turn to other valuation ratios such as
Price to book or
Price to sales.