PE Ratio Explained for Beginners

Описание: ➜ P/E Ratio = Price / Earnings

The purpose of the PE ratio is to see how expensive a company is compared to how much profits it’s made over the past full year.

The PE ratio can either be price per share divided by earnings per share... or it can be the price for the entire company which is also known it’s market cap divided by the total amount of net profits over the past full year.

Most websites and apps will show you the PE ratio using the per share information.. But you’ll get about the same answer whether it’s being calculated on a per share basis or on the basis of the entire company.

However they won’t always be exactly the same and this would happen if the company’s share count has changed throughout the past year.

Companies can issue new shares and they can also buy back shares and both of these actions will cause the shares-outstanding amount to change.

A lower PE ratio means less expensive and a higher PE ratio means more expensive… but as you’ll see in a moment there is a bit more to it than just that.

For example though: Would you rather buy a company for a price that is 5 times the amount it made in profits over the past full year, or... Would you rather buy a company for a price that is 30 times the amount it made in profits over the past full year?

Well 5 times earnings is definitely cheaper than paying 30 times earnings... so 5 times earnings is definitely sounding like a much more attractive price.

But the one major problem with the PE ratio is that it doesn’t at all account for future growth in earnings.

Net income, net profit, and earnings are all different names for the same thing.

It’s the money left over after all costs of good, all expenses, and all taxes have been paid. This is the money that could be paid out to shareholders as a dividend or reinvested back into the company to grow more.

The PEG ratio is the Price-to-earnings Ratio divided by the growth rate.

So if a company was trading at a PE ratio of 10 and was growing its earnings by 18% per year it would have a PEG ratio of 10 divided by 18 = 0.55.

If a company was trading at a PE ratio of 20 and growing its earnings by only 5% per year, it would have a PEG ratio of 20 divided by 5 = 4.

Similarly to the PE ratio, with the PEG ratio, lower is better…


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PE Ratio Explained for dummies