The price-to-earnings ratio is a fundamental analysis tool that is calculated by dividing the current company stock price by yearly earnings per share. Company analysis looks at financial ratios and accounting statements to determine how a company is performing and whether or not it may be a good investment.
The PE ratio is determined by dividing the company’s stock price by its earnings per share, with the resulting figure being the number of years it will take for the business to earn its current price. Here’s an example:
Company X’s stock price is currently $40. The company has 100 million shares on issue and last year had earnings before interest and tax (EBIT) of $200 million, or $2 per share. Dividing 40 by 2 gives us a price-to earnings ratio (also called a “multiple) of 20, meaning it would take 20 years for the company to earn back its valuation at current levels. A trader or investor can then compare company X’s PE ratio with that of other companies to see whether it is fairly valued at present or not. The ratio can also be used across an entire index, such as the S&P 500.