Price to Earnings Ratio – Introduction and Interpretation
Price to Earnings Ratio (P/E) is an analysis tool used to evaluate publicly traded stock. It is a simple mathematical formula relating the stock price in the market against the prior 12 months of earnings. The following is the formula:
Price to Earnings Ratio = Current Stock Price in the Market/Prior 12 Months of Earnings per Share
It is most commonly used by investors (buyers of stock) to determine the likelihood that the current trading price of the stock is beneficial or detrimental to the buyer. Historical trigger points to investing in the stock have been ratios of 19 or less. As an example, if the current price of the stock is $81 then to have a ratio of 19 or less, the earnings would have to have been $4.26 or more during the previous 12 months.
P/E ratio of 19 = $81 Current Stock Price/Unknown
Solve for the unknown: 19 = 81/X
Therefore: 19/81 = 4.26
As a buyer, the lower the P/E the more beneficial the opportunity to purchase the stock. If you are selling stock, the higher the P/E the greater the opportunity to make money. How so?
Price to Earnings Ratio – Purchasing Stock in the Market
As a company earns money it has to utilize those earnings in some fashion. It may distribute the earnings to the shareholders via dividends or