The PE Ratio is one of the oldest ways to show the value of a stock. The “P” stands for the current stock price, and the “E” Stands for the company’s annual earnings per share(EPS). If you divide a company’s current stock price by it’s annual EPS, you have that company’s P/E Ratio. Here’s an example of how to calculate the P/E Ratio of a company. I’ll use Microsoft(MSFT) for this example. On March 8th, 2005, Microsoft’s stock closed at $25.40. Microsoft’s recent annual earnings per share(EPS) is $0.92. So $25.40/$0.92 gives us a P/E Ratio of 27.6
So what does the PE Ratio tell us? – The PE Ratio gives an investor a better understanding of a company’s value. Basically with the PE Ratio, you are calculating how many dollars you are paying for each dollar of a company’s earnings. With the Microsoft example, you will be paying $27.60 for every $1.00 of earnings. So if a stock has a high PE Ratio, then it could be overpriced. If a stock has a low PE Ratio, it could be a underpriced. A low PE Ratio would be 5-35. A high PE Ratio would be anything above 35. But don’t be foold by a high PE ratio. Sometimes the PE Ratio can be decieving. In some cases a stock could have a high P/E Ratio but be a great investment.
If a a company’s stock has a low PE Ratio, yet the company’s earnings per share has been steadily increasing year after year, that companies stock could be undervalued. You can also compare the PE Ratio of a company to others in the same industry.
