Understanding & Calculating the Price-to-Earnings (P/E) Ratio

The P/E ratio is one way that investors frequently use to value stocks. You can calculate this ratio if you have access to the basic financial statement of a particular company. Here are the basics of how to calculate a P/E ratio.

P/E Ratio

The term "P/E ratio" stands for "price-earnings ratio." This is a method that is used to portray the relationship between the price of a stock and the earnings that that particular company has generated over a specific period. This ratio shows you exactly how much investors will pay for one dollar of earnings that the company has generated. Whenever calculating this ratio, they will use the earnings over the last year for the company.

Calculation

The process of calculating a P/E ratio is very simple. You will take the current market value of each share of the company stock and divide it by the earnings per share. The value that you get will be the price-earnings ratio.

Comparing

Just looking at this value is not really going to tell you much. Most investors use this number as a point of comparison to other companies in the same sector or industry. In other words, they compare companies' P/E ratios with one another.