Price to earnings ratio
(PER).
The ratio of the equity value of a company to its accounting earnings (profit after tax).
The PER (or PE ratio) can be calculated either on a per-share basis or on the total equity value and total earnings, giving identical results.
Per share:
PE ratio = Current share price ÷ Earnings per share.
On total values:
PE ratio = Total equity value ÷ Total earnings.
For example if Company A's total equity value is $630m and its relevant earnings are $63m,
the PE ratio = $630m / $63m
= 10.
The Price to earnings ratio reflects the market's perception of the risk and the future growth prospects of the company.
A higher PE ratio generally indicates that the market perceives:
- better growth
- lower risk
- or both
Lower PE ratios suggest lower growth (or indeed decline), higher risk, or both
PE ratios can also be used as a very simple estimation or comparison model, for corporate valuation.
In another case, say comparable PE ratios for an unlisted Company B are 12, and Company B's relevant earnings are $10m.
The total value of Company B's equity can be estimated on this basis as:
12 x $10m
= $120m.
Very simplistically, shares trading on low PE ratios might be perceived as relatively cheap. Similarly, shares trading on higher PE ratios would be seen as relatively expensive.
A better use of PE ratios is as a sense-check of the results and insights from other valuation methods.
Sometimes written as P/E ratio.
Also known as price earnings ratio.
