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The price-to earnings ratio (P/E) is a ratio that determines the value of a company. It measures its current share price in relation to its earnings (EPS). Sometimes, the earnings multiple or price multiple is also known as the P/E ratio.
Analysts and investors use P/E ratios to compare the relative values of shares in an apples-to–apples comparison. It can be used to evaluate a company’s historical records or to compare aggregate markets with one another over time. Most scanners provide P/E as a filter criteria.
The P/E can be calculated on either a forward-looking (backward-looking), or a trailing basis (forward-looking).
Analysts and investors use the price-to-earnings (P/E), one of the most popular tools to determine a stock’s relative value. The P/E ratio is used to determine if a stock’s value is too high or low. The company’s P/E ratio can be compared to other stocks in the industry or against the wider market.
Forward Price-to Earnings
These two types EPS metrics are used to calculate the most popular types of P/E ratios, the forward and trailing P/E. The third, and less popular variation, uses the sum of two quarters actual and the estimates for the next two.
One of the best ways you can avoid investing in stocks with low P/E ratios is to look at their history. If a stock’s past P/E ratio history is negative, and it has been so for many years, what are the catalysts that will allow it to trade at higher prices? A stock that is a growth stock trading at its highest ever P/E ratio but seeing a decline in growth rates may be on the verge of falling soon.
If a company is near the end of its life cycle and still has its business model in place, expect multiple expansions over the next years. You may also be willing to pay a high ratio for P/E.
What is a good price-to-earnings ratio?
The industry the company operates will determine what a good and bad price-to earnings ratio is. Certain industries will have higher average prices-to-earnings rates, while others will have lower ratios. You can compare the industry average P/E to see if a certain P/E ratio is high, or low.