What is a P/E Ratio?

2 mn read

For the experienced investor, the Price-to-Earnings (P/E Ratio) is your best friend. For those unfamiliar with what a P/E ratio is, that’s okay. Because not many people are familiar with the P/E Ratio is supposed to inform you on. I wanted to write this article in order to clear the air regarding the ratio. Once you start to understand what the ratio does, you will be that much better of an investor. The more you know the more money you can make! Let’s first answer the question “What is a P/E Ratio?”

The P/E Ratio is probably the most valuable formula in all of investing. In my opinion at least. Because it is the most valuable formula let’s discuss what the price-to-earnings ratio stands for. The price-to-earnings ratio is the ratio for valuing a company that measures its current share price relative to its earnings per share (EPS). That is simple enough right! Good news, that’s not the end of the ratio. You are probably wondering how you would use it. Well, the ratio can be used to compare a company against its own historical record. You can also compare it to a collection of markets against one another or over time.

How to Calculate a P/E Ratio?

Now, that you know what the price-to-earnings ratio is, let’s calculate it. But don’t worry calculating it is very simple. For an example see the below formula:

P/E = Price per share/ Earnings per share

See, that wasn’t too bad! Now that you know how to calculate it let us discuss why it’s useful.

Calculating the ratio can seem daunting, but as you can see it’s such a simple formula. Don’t make this harder than it needs to be.

What does the P/E Ratio Mean when Investing?

The most widely used tool in investing is the price-to-earnings ratio. Investors and analysts utilize the ratio to get a relative value of a stock. The price-to-earnings ratio helps an investor determine whether a stock is overvalued or undervalued. A company’s price to earnings can also be used to compare stocks in the same industry or against the broader market.

Let’s take a look at a real-world example. We will utilize Walmart’s stock as an example. Click here to see Walmart’s stock.

Takeaways

I hope this was helpful. Understanding the price-to-earnings ratio will take your investing journey to the next level. Continue to read up on it and find better ways to add it into your formula for investing. You’ll for sure see the difference!

If you enjoyed this article check out my other investing articles!