Review How the Price-to-earnings Ratio and Enterprise Value Ratios Are Used to Compare Stock Values

Price/earnings ratio (P/E ratio)

The P/East ratio helps investors determine whether to invest. Bankrate explains.

What is the price/earnings ratio?

The cost/earnings ratio, too called the P/East ratio, tells investors how much a company is worth. The P/East ratio simply the stock toll divided past the company'due south earnings per share for a designated catamenia like the past 12 months. The price/earnings ratio conveys how much investors will pay per share for $1 of earnings.

Deeper definition

Investors look at a visitor's price/earnings ratio to determine whether to invest. They use the market value per share in relation to earnings per share to find the ratio. When the P/E ratio is calculated beyond a menstruum of previous quarters, it's called a trailing P/E, which is the most common type. When the cost/earnings ratio is calculated using estimated net earnings of upcoming quarters, it's called a time to come P/Due east.

The P/E ratio shows how much growth investors wait from companies they invest in. A high ratio indicates that investors are paying much more per share than the company is earning, which is common in new businesses with a lot of investment capital, like tech start-ups. Lower ratios signal that growth has slowed, only that doesn't necessarily mean the company is failing; in fact, a lower P/E ratio may mean the visitor has solidified its market share.

The price/earnings ratio as well can exist used to gauge the market as a whole if different companies from the aforementioned industry are examined over the same menses. This kind of comparison tin help an investor determine if a given company is over- or undervalued.

With the P/E ratio in mind, y'all might be ready to invest. With a loftier-involvement savings account, you can build funds to put toward stocks.

Toll/earnings ratio instance

On September 30, 2015, Apple's stock ended the mean solar day at a price of $110.30. Apple'south earnings per share for the trailing 12 months was $eight.66. Split up the stock price past the EPS and — voila! — you go a price/earnings ratio of 12.74.

That same day, Morningstar, an investment inquiry business firm, says that the P/E ratio of the S&P 500 was 18. Together, this information informs investors that Apple's stock may take been undervalued as of that date.