Ten Stock Analysis Ratios Used By The Pros: Price-to-Earnings Ratio

Second Key Ratio :

Price-to-Earnings Ratio

One of the most commonly used metrics to analyse and compare a stock’s valuation. This ratio values stocks in terms of their net earnings. There are different variations of Price-to-Earnings (PE) to reflect the period of earnings. A trailing PE ratio uses the previous 4 quarters’ earnings whereas a projected PE ratio uses analyst estimates for the next 4 quarters of earnings. Projected or forward PE ratios are widely used in analysis as it is most useful for forecasting future share prices. PE ratios are effective at analysing stocks within the same sector but not so much for those in different industry groups. For example, technology stocks generally have a higher PE than utility stocks due to the perception of higher growth within the industry. Investors are willing to buy stocks with a higher PE if there is a strong potential for growth and higher earnings in the future, but usually see more value in those with a lower PE.

Formula:

Price-to-Earnings Ratio = Market Capitalisation / Net Income

or

Price-to-Earnings Ratio = Market Value per Share / Earnings per Share

 

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