Understanding P/E Rations.
The price-to-earnings ratio, or P/E ration, is one of the most common ways investors compare companies. It measures how much the market is willing to pay today for each dollar of profit a company makes. To calculate it, divide the share price by the company’s earnings per share.
If a company trades on a high P/E, it means investors are paying a lot for each dollar of profit. This usually happens when the market expects the company to grow quickly in the future. If a company has a low P/E, it may suggest the shares are cheaper relative to profits. That could mean good value, or it could reflect weak growth prospects or risks.
The P/E ratio makes the most sense whern comparing companies in the same industry. A bank, a miner, and a tach start-up may all have very different average P/E levels, so comparing them directly isn’t very useful. For beginners, it’s best to think of P/E as a quick snapshot of how optimistic or cautious the market feels about a company’s future earnings.