Price-Earnings Ratio – P/E Ratio

What Does Price-Earnings Ratio – P/E Ratio Mean?

This is a valuation ratio of a company’s current share price compared to its per-share earnings (EPS).

P/E Ratio is calculated as:

Price Earning ratio = Market Price of a share / Earnings Per Share

For example, if a company is currently trading at Tk.100 a share and earnings over the last 12 months (EPS) were Tk. 5 per share, the P/E ratio for the stock would be 20.0 (Tk. 100/Tk. 5).

EPS is usually from the last four quarters (trailing P/E), but sometimes it can be taken from the estimates of earnings expected in the next four quarters (projected or forward P/E).

A third variation uses the sum of the last two actual quarters and the estimates of the next two quarters.

P/E Ration is also sometimes known as “price multiple” or “earnings multiple”.

In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E.

However, the P/E ratio doesn’t tell us the whole story by itself. It’s usually more useful to compare the P/E ratios of one company to other companies in the same industry, to the market in general or against the company’s own historical P/E. It would not be useful for investors using the P/E ratio as a basis for their investment to compare the P/E of a financial company (e.g. AB Bank) to a utility company (e.g. DESCO) as each industry has much different growth prospects.

The P/E is sometimes referred to as the “multiple”, because it shows how much investors are willing to pay per Taka of earnings. If a company were currently trading at a multiple (P/E) of 20, the interpretation is that an investor is willing to pay Tk. 20 for Tk. 1 of  current earnings.

It is important that investors note a problem that arises with the P/E measure, and to avoid basing a decision on this measure alone. The denominator (earnings) is based on an accounting measure of earnings that is susceptible to forms of manipulation, making the quality of the P/E only as good as the quality of the underlying earnings number