Enterprising Investor Forum

Price-to-Earnings Ratio (P/E) Wednesday, June 20, 2007

The P/E ratio tells us how much an investor is willing to pay for every dollar of earnings that a company generates. Generally, a high P/E ratio suggests that there is an expectation for higher earnings growth and therefore an expectation for the company to appreciate in value. This ratio is also known as “price multiple” or “earnings multiple”.

As with most ratios, the number alone can be misleading. It is important to compare the P/E ratio of companies within the same industry, to the market in general or against the company’s own historical P/E.

You will probably come across general benchmarks ranging from 12 to 20 but we strongly encourage you to do your own research because as you can imagine, industries vary considerably (i.e. P/E ratios in the technology sector are usually around 40 vs. 8 for the textile sector).

Just because a company’s P/E ratio is going down, does not mean that the company’s prospects are decreasing. It could simple mean that earnings are growing at a faster pace than the stock price and that this could be an interesting trigger to open a position. Furthermore, please note that companies with negative earnings (meaning that they are actually losing money) do not have a P/E ratio.

The P/E ratio is calculated by dividing the current share price by Earnings per Share (EPS).