P/E Ratio

What is it ?

A PE ratio measures the expectation of company performance with regard to its earnings growth potential and risk.

It is calculated by dividing the share price by the annual earnings per share.

How/where is it used ?

It is a tool that can be used to evaluate a company against competitors. For example, a company with a higher PE ratio than its competitors could be an indication that it has a value placed on it based on higher than expected growth potential than competitor companies. In this example a company with a PE ratio of 20 would expect earnings growth of 20%, compared to say an average figure of 10 for competitors, where earnings growth is expected to be only 10%. However it must be remembered that the figures show anticipated growth, not actuals.

In this same example, if there is an economic downturn, then it is likely that the company with anticipated earnings growth of 20% is likely to be vulnerable as the actual growth would not be achieved and the share price would suffer as a result.

Like any measure, PE should not be used as the sole vehicle for measuring performance.

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