P/E ratio

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The P/E ratio (price-to-earnings ratio) of a stock (also called its ‘multiple’) is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share. P/E is a financial ratio used for valuation: a higher P/E ratio means that investors are paying more for each unit of net income. P/E ratio shows current investor demand for a company share.

A P/E of 0-10 indicates stocks that are undervalued or where the company’s earnings are thought to be in decline. Alternatively, current earnings may be substantially above historic trends or the company may have profited from selling assets. A P/E of 10-17 is considered fair value. The average U.S. equity P/E ratio from 1900 to 2005 is 14. A P/E of 17-25 indicates that the stock is overvalued or that the company’s earnings have increased since the last earnings figure was published. The stock may also be a growth stock with earnings expected to increase substantially in the future. A company whose shares have a high P/E (over 25)  may have high expected future growth in earnings or the stock may be the subject of a speculative bubble.

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