What is Price Earnings (P/E) ratio?
The Price Earnings Ratio (P/E Ratio) is the correlation between a company’s share price and earnings per share (EPS). It is a prevalent ratio that provides an investor an enhanced sense of the value of a company. The P/E ratio shows the expectations of the market and is the price you must pay per unit of current earnings (or future earnings, as the case may be).
Earnings are critical for valuation of a company’s stock because investors want to know how profitable a company is and will be in the future. Additionally, if the company doesn’t grow and the current level of earnings remains constant, the P/E can be interpreted as the number of years it will take for the company to pay back the amount paid for each share.
P/E ratio is computed as Share price divided by Earnings per share. High PE indicates growth in stocks and indicates positive performance of the company. Companies having high P/E ratio are also considered as highly volatile and investment in these companies are considered as risky.
Low P/E ratio is often considered as undervalued stocks. Investors can often buy undervalued stock at a discount and then profit when the price of that stock climbs.