P/E ratio is an important metric used to assess the relative value of a stock (or sometimes an index or industry). It is calculated as its share price divided by earnings per share (EPS).
P/E ratio is also often referred to price to earnings, PE ratio or price-earnings multiple.
If Lloyds Banking Group’s share price is 100p and its EPS is £0.04 then its P/E is 25 (100/4=25).
By dividing a company’s current share price by its earnings per share, traders are able to assess the level at which shares are trading compared to the profit a company is making. If a company has a high P/E ratio, then those buying its shares are usually anticipating that earnings will increase in the future to justify its valuation. It may also indicate that the company is currently overvalued.
P/E ratios are usually calculated using 12-month trailing EPS. It is possible, however, to use projected earnings to create a forward P/E ratio. Many analysts will also create normalised P/E by taking a company’s normalised earnings.
Different industries will have different average P/E ratios, so the definition of a high P/E varies between assets. Growth companies will tend to trade with higher P/E ratios than established blue chip stocks.
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