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edward發表於 2025-2-19 18:01 | 只看該作者

Earnings Per Share(EPS):What It Is and How to Calculate(Jason Fernando)

Earnings PerShare (EPS):
What It Is andHow to Calculate


By Jason Fernando

Updated January 24, 2025

Reviewed by David Kindness

Fact checked by Melody Kazel



How to Value a Company
What Is EarningsPer Share (EPS)?


Earnings per share (EPS) is a commonly used measure ofa company's profitability. It indicates how much profit each outstanding shareof common stock has earned. Generally speaking, the higher a company's EPS, themore profitable it is considered to be.

EPS is calculated by dividing a company's net income bythe total number of outstanding shares.


Key Takeaways
  • Earnings per share (EPS) is a company's net income     subtracted by preferred dividends and then divided by the number of common     shares it has outstanding.
  • EPS indicates how much money a company makes for each share of its stock and     is a widely used metric for estimating corporate value.
  • A higher EPS indicates greater value because investors     will pay more for a company's shares if they think the company has higher     profits relative to its share price.
  • EPS can be arrived at in several forms, such as     excluding extraordinary items or discontinued operations, or on a diluted     basis.
  • Like other financial metrics, earnings per share is     most valuable when compared against competitor metrics, companies of the     same industry, or across a period of time.

Investopedia / Alex Dos Diaz
Earnings PerShare Equation


Earnings per share value is calculated as net income(also known as profits or earnings) divided by available shares. A morerefined calculation adjusts the numerator and denominator for shares that couldbe created through options, convertible debt, or warrants. The numerator of theequation is also more relevant if it is adjusted for continuing operations.

Earnings per Share
=End-of-Period Common Shares OutstandingNet Income − Preferred Dividends​

To calculate a company's EPS, the balance sheet andincome statement are used to find the period-end number of common shares,dividends paid on preferred stock (if any), and the net income orearnings. It is more accurate to use a weighted average number of commonshares over the reporting term because the number of shares can change overtime. Understanding how to find EPS is crucial for evaluating a company'sprofitability.

Any stock dividends or splits that occur must bereflected in the calculation of the weighted average number of shares outstanding.Some data sources simplify the calculation by using the number of sharesoutstanding at the end of a period.


What DoesEarnings Per Share (EPS) Indicate?


Earnings per share is one of the most importantfinancial metrics employed when determining a firm's profitability on anabsolute basis. It is also a major component of calculating the price-to-earnings (P/E) ratio, where the E in P/E refers to EPS. By dividing a company's share priceby its earnings per share, an investor can see the value of a stock in terms ofhow much the market is willing to pay for each dollar of earnings.


Earnings per share shows an investor how to pickstocks, when used along with other indicators. If you have an interest in stocktrading or investing, your next step is to choose a broker that worksfor your investment style.


Comparing EPS in absolute terms may not have muchmeaning to investors because ordinary shareholders do not have direct access tothe earnings. Instead, investors will compare EPS with the share price of thestock to determine the value of earnings and how investors feel about futuregrowth.


Example of EPS
Say that the calculation of EPS for three companies atthe end of the fiscal year was as follows:


[td]      
   EPS Example
   
   Company
   		   Net   Income
   		   Preferred   Dividends
   		   Weighted   Common Shares
   		   Basic   EPS
   
  Company A
  		  $7.6B
  		  $0
  		  3.98B
  		  $7.6/3.98 = $1.91
  
  Company  B
  		  $18.23B
  		  $1.61B
  		  10.2B
  		  $18.23-$1.61/10.2  
  = $1.63
  
  Company C
  		  $1.67B
  		  $0
  		  0.541B
  		  $1.67/0.541 = $3.09
  


Basic EPS vs. DilutedEPS


The formula in thetable above calculates the basic EPS of each ofthese select companies. Basic EPS does not factor in the dilutive effect ofshares that could be issued by the company. When the capital structure of acompany includes items such as stock options, warrants, or restricted stockunits (RSU), these investments—if exercised—could increase the total number ofshares outstanding in the market.


To better illustrate the effects of additionalsecurities on per-share earnings, companies also report the diluted EPS, which assumesthat all shares that could be outstanding have been issued.


For example, say the total number of shares that couldbe created and issued from Company C's convertible instruments at fiscalyear-end was 23 million. If this number is added to its total sharesoutstanding, its diluted weighted average shares outstanding will be 541million + 23 million = 564 million shares. The company's diluted EPS is,therefore, $1.67 billion /.564 million = $2.96.


Sometimes an adjustment to the numerator is requiredwhen calculating a fully diluted EPS. For example, sometimes a lender willprovide a loan that allows them to convert the debt into shares under certainconditions.


The shares that would be created by the convertibledebt should be included in the denominator of the diluted EPS calculation, butif that happened, then the company wouldn’t have paid interest on the debt. Inthis case, the company or analyst will add the interest paid on convertibledebt back into the numerator of the EPS calculation so the result isn’tdistorted.




EPS ExcludingExtraordinary Items


Earnings per share can be distorted, both intentionallyand unintentionally, by several factors. Analysts use variations of the basicEPS formula to avoid the most common ways that EPS may be inflated.


Imagine a company that owns two factories that makecell phone screens. The land on which one of the factories sits has becomevery valuable as new developments have surrounded it over the past few years.The company’s management team decides to sell the factory and build another oneon less valuable land. This transaction creates a windfall profit for the firm.


Though this land sale has created real profits for thecompany and its shareholders, it is considered an “extraordinary item” becausethere is no reason to believe the company can repeat that transaction in thefuture. Shareholders might be misled if the windfall is included in thenumerator of the EPS equation, so it is excluded.


A similar argument could be made if a company hadan unusual loss—maybe thefactory burned down—which would have temporarily decreased EPS and should beexcluded for the same reason.


The Formula forEPS Excluding Extraordinary Items Is:

EPS=Net Income − Pref.Div. (+or−) Extraordinary Items/Weighted Average Common Shares

Weighted Average Common SharesNet Income − Pref.Div. (+or−) Extraordinary Items​

EPS FromContinuing Operations


A company started the year with 500 stores and had an EPS of $5.00.However, assume that this company closed 100 stores over that period and endedthe year with 400 stores. An analyst will want to know what the EPS was forjust the 400 stores the company plans to continue with into the next period. Inthis example, that could increase the EPS because the 100 closed stores wereperhaps operating at a loss. By evaluating EPS from continuing operations,an analyst is better able to compare prior performance to current performance.


EPS and Capital


An important aspect of EPS that is often ignored is thecapital that is required to generate the earnings (net income) in thecalculation. Two companies could generate the same EPS, but one could do sowith fewer net assets; that company would be more efficient at using itscapital to generate income and, all other things being equal, would be a"better" company in terms of efficiency. A metric that can be used toidentify more efficient companies is the return on equity (ROE).




EPS and Dividends


Although EPS is widely used as a way to track acompany’s performance, shareholders do not have direct access to those profits.A portion of the earnings may be distributed as a dividend, but all or aportion of the EPS can be retained by the company. Shareholders, through theirrepresentatives on the board of directors, wouldhave to change the portion of EPS that is distributed through dividends to access more of those profits.


EPS andPrice-to-Earnings (P/E)


Making a comparison of the P/E ratio within an industrygroup can be helpful, though in unexpected ways. Although it seems like a stockthat costs more relative to its EPS when compared to peers might be“overvalued,” the opposite tends to be the rule.
Regardless of its historical EPS, investors are willingto pay more for a stock if it is expected to grow or outperform its peers. Ina bull market, it is normalfor the stocks with the highest P/E ratios in a stock index to outperform theaverage of the other stocks in the index.


What Is RollingEPS



Investopedia / Paige McLaughlin




Rolling EPS gives an annual earnings per share (EPS)estimate by combining EPS from the past two quarters with estimated EPS from the next two quarters.




It may be calculated with the following formula:

Rolling EPS = (Net income from the previous twoquarters + next two quarters – preferred dividends) / average sharesoutstanding




Earnings per share (EPS), a company's profit divided by the amount of common stock it has incirculation, is one of the most closely observed metrics in investing. Otherthan serving as an indicator of how much money pulled in after accounting forall expenses was allotted to each share of common stock, it’s also frequentlyused to determine if a company is reasonably valued.


EPS is a key component of the price-to-earnings (P/E)valuation ratio. Divide the share price by EPS and you get a multiple denotinghow much we pay for $1 of a company’s profit. In other words, if a company iscurrently trading at a P/E of 20x that would mean an investor is willingto pay $20 for $1 of current earnings.


The share price of a stock may look cheap, fairlyvalued or expensive, depending on whether you look at historical earnings orestimated future earnings.


Earnings forecasts arebased on educated guesswork from analysts and are often too rosy, possibly making thevaluation look cheap. Historical earnings, on the other hand, are set in stonebut may not fairly represent a company's legitimate growth potential. RollingEPS represents a compromise, giving investors a blend of both.




Rolling EPS vs.Trailing EPS


Rolling EPS shouldn’t be confused with trailing EPS, which mainlyuses the previous four quarters of earnings in its calculation.


Sometimes you may hear or spot the term rollingtrailing EPS, as well. What this means is that EPS will change as the mostrecent earnings are added to the calculation and earnings from five quartersago are dropped to make way for them.




What Is a GoodEarnings Per Share Ratio?


What counts as a good EPS will depend on factors suchas the recent performance of the company, the performance of its competitors,and the expectations of the analysts who follow the stock. Sometimes, a companymight report growing EPS, but the stock might decline in price if analysts wereexpecting an even higher number.


Likewise, a shrinking EPS figure might nonetheless leadto a price increase if analysts were expecting an even worse result. It isimportant to always judge EPS in relation to the company’s share price, such asby looking at the company’s P/E or earnings yield.


What Is theDifference Between Basic EPS and Diluted EPS?

Analysts will sometimes distinguish between basic anddiluted EPS. Basic EPS consists of the company’s net income divided by itsoutstanding shares. It is the figure most commonly reported in the financialmedia and is also the simplest definition of EPS.


Diluted EPS, on the other hand, will always be equal toor lower than basic EPS because it includes a more expansive definition of thecompany’s shares outstanding. Specifically, it incorporates shares that are notcurrently outstanding but could become outstanding if stock options and otherconvertible securities were to be exercised.


What Is theDifference Between EPS and Adjusted EPS?


Adjusted EPS is a type of EPS calculation in which theanalyst makes adjustments to the numerator. Typically, this consists of addingor removing components of net income that are deemed to be non-recurring.
For instance, if the company’s net income was increasedbased on a one-time sale of a building, the analyst might deduct the proceedsfrom that sale, thereby reducing net income. In that scenario, adjusted EPSwould be lower than basic EPS.


What Are SomeLimitations of EPS?


When looking at EPS to make an investment or tradingdecision, be aware of some possible drawbacks. For instance, a company can gameits EPS by buying back stock, reducing the number of shares outstanding, andinflating the EPS number given the same level of earnings.


Changes to accounting policy for reporting earnings canalso change EPS. EPS also does not take into account the price of the share, soit has little to say about whether a company's stock is over or undervalued.


How Do YouCalculate EPS Using Excel?
After collecting the necessary data, input the netincome into Excel, preferreddividends, and number of common shares outstanding into three adjacentcells, say B3 through B5. In cell B6, input the formula "=B3-B4" tosubtract preferred dividends from net income. In cell B7, input the formula"=B6/B5" to render the EPS ratio.

The Bottom Line
Earnings per share (EPS) is an important profitabilitymeasure used in relating a stock's price to a company's actual earnings. Ingeneral, higher EPS is better but one has to consider the number of sharesoutstanding, the potential for share dilution, and earnings trends over time.If a company misses or beats analysts' consensus expectations for EPS, itsshares can either crash or rally, respectively.


Price-to-Earnings(P/E) Ratio: Definition, Formula, and Examples

By Jason Fernando
UpdatedJuly 30, 2024
Reviewed by Gordon Scott
Fact checked by David Rubin
Part of the Series
How to Value a Company
Definition
The price-to-earnings ratio compares a company's shareprice with its earnings per share. Analysts and investors use it to determinethe relative value of a company's shares in side-by-side comparisons.
What Is the Price-to-Earnings (P/E) Ratio?
The price-to-earnings (P/E) ratio measures a company'sshare price relative to its earnings per share (EPS). Often called theprice or earnings multiple, the P/E ratio helps assess the relative value of acompany's stock. It's handy for comparing a company's valuation against itshistorical performance, against other firms within its industry, or the overallmarket.
KeyTakeaways
  • The price-to-earnings (P/E) ratio     is the proportion of a company's share price to its earnings per share.
  • A high P/E ratio could mean that     a company's stock is overvalued or that investors expect high growth     rates.
  • Companies with no earnings or are     losing money don't have a P/E ratio because there's nothing to put in the     denominator.
  • The two most used P/E ratios are     forward and trailing P/E.
  • P/E ratios are most valuable when     comparing similar companies in the same industry or for a single company     over time.



Understanding the P/E Ratio

The P/E ratio is one of the most widely used byinvestors and analysts reviewing a stock's relative valuation. It helps todetermine whether a stock is overvalued or undervalued. A company's P/E canalso be benchmarked against other stocks in the same industry or against thebroader market, such as the S& 500 Index.
Analysts interested in long-term valuation trends canlook at the P/E 10 or P/E 30 measures, which average the past 10 or 30 years ofearnings. These measures are often used when trying to gauge the overall valueof a stock index, such as the S& 500, because these longer-term metricscan show overall changes through several business cycles.
The P/E ratio of the S& 500 going back to 1927 hashad a low of roughly 6 in mid-1949 and been as high as 122 in mid-2009, rightafter the financial crisis. As of April 2024, the S& 500's P/E ratio was26.26.1
P/E Ratio Formula and Calculation
The formula and calculation are as follows:
P/E Ratio=Market value per share/Earnings per share
To determine the P/E value, divide the stock price by the EPS.
The stock price (P) can be found simply by searching astock’s ticker on a reputable financial website. Although this concrete valuereflects what investors currently pay for the stock, the EPS is related toearnings reported at different times.
EPS is generally given in two ways. Trailing 12 months(TTM) represents the company's performance over the past 12 months. Another isfound in earnings releases, which often provide EPS guidance. This isthe company's advice on what it expects in future earnings. These differentversions of EPS form the basis of trailing and forward P/E, respectively.



When to Review the P/E Ratio

Analysts and investors review a company's P/E ratio todetermine if the share price accurately represents the projected earnings pershare.


Forward Price-to-Earnings
The most commonly used P/E ratios are the forward P/E andthe trailing P/E. A third and less typical variation uses the sum of thelast two actual quarters and the estimates of the following two quarters.
The forward (or leading) P/E uses future earningsguidance rather than trailing figures. Sometimes called "estimatedprice to earnings," this forward-looking indicator helps compare currentearnings to future earnings and can clarify what earnings will look likewithout changes and other accounting adjustments.
However, there are problems with the forward P/Emetric—namely, companies could underestimate earnings to beat the estimated P/Ewhen the next quarter's earnings arrive. Furthermore, external analysts mayalso provide estimates that diverge from the company estimates, creatingconfusion.




Trailing Price-to-Earnings
The trailing P/E relieson past performance by dividing the current share price by the totalEPS for the previous 12 months. It's the most popular P/E metric because it'sthought to be objective—assuming the company reported earnings accurately. Butthe trailing P/E also has its share of shortcomings, including that a company’spast performance doesn’t necessarily determine future earnings.
Investors often base their purchases on potentialearnings, not historical performance. Using the trailing P/E ratio can be aproblem because it relies on a fixed earnings per share (EPS) figure, whilestock prices are constantly changing. This means that if something significantaffects a company's stock price, either positively or negatively, the trailingP/E ratio won't accurately reflect it. In essence, it might not provide anup-to-date picture of the company's valuation or potential.
The trailing P/E ratio will change as the price of acompany’s stock moves because earnings are released only each quarter, whilestocks trade whenever the market is open. As a result, some investors preferthe forward P/E. If the forward P/E ratio is lower than the trailing P/E ratio,analysts are expecting earnings to increase; if the forward P/E is higher thanthe current P/E ratio, analysts expect them to decline.




Valuation From P/E
In addition to indicating whether a company’sstock price is overvalued or undervalued, the P/E ratio can reveal howa stock’s value compares with its industry or a benchmark like the S&500.
The P/E ratio indicates the dollar amount an investorcan expect to invest in a company to receive $1 of that company’s earnings.Hence, it’s sometimes called the price multiple because it shows how muchinvestors are willing to pay per dollar of earnings. If a company trades at aP/E multiple of 20x, investors are paying $20 for $1 of current earnings.
The P/E ratio also helps investors determine astock’s market value compared with the company’s earnings. That is,the P/E ratio shows what the market is willing to pay today for a stockbased on its past or future earnings. A high P/E ratio could signal that astock’s price is high relative to earnings and is overvalued. Conversely, a lowP/E could indicate that the stock price is low relative to earnings.




Examples of the P/E Ratio
Let's clarify this with an example, looking at FedExCorporation (FDX). We can calculate the P/Eratio for FDX as of Feb. 9, 2024, when the company's stock price closed at$242.62. The company's earnings per share (EPS) for the trailing 12 months was$16.85.2
Therefore, FDX's P/E ratio was as follows:
$242.62 / $16.85 = 14.40



Comparing Companies Using P/E
Let's now look at two energy companies to see theirrelative values.
Hess Corporation (HES) had the following data at theclose of Feb. 9, 2024. We'll use the diluted EPS to account for what wouldoccur should all convertible securities be exercised:
  • Stock price142.07
  • Diluted 12 months trailing EPS:     $4.49
  • P/E: 31.64 ($142.07 / $4.49)3
HES thus traded at about 31 times trailing earnings.However, the P/E of 31 isn't helpful unless you have something to compare itwith, like the stock's industry group, a benchmark index, or HES's historicalP/E range.
HES's P/E ratio was higher than the S& 500, which,as of Feb. 9, 2024, was about 22 times 12-month trailing earnings.4 To compareHES's P/E ratio to a peer, let's look at Marathon Petroleum Corporation (MPC):
  • Stock price: $169.97
  • Diluted 12 months trailing EPS:     $23.64
  • P/E: 7.195
When you compare HES's P/E of 31 to MPC's of 7, HES'sstock could appear substantially overvalued relative to the S& 500 andMPC. Alternatively, HES's higher P/E might mean that investors expect muchhigher earnings growth in the future than MPC.
However, no ratio can tell you everything you needabout a stock. Before investing, it's wise to use various financial tools todetermine whether a stock is fairly valued.




Investor Expectations
In general, a high P/E suggests that investors expecthigher earnings growth than those with a lower P/E. A low P/E can indicate thata company is undervalued or that a firm is doing exceptionally well relative toits past performance. When a company has no earnings or is posting losses,the P/E is expressed as N/A. Though it's possible to calculate a negative P/E, it's not common.
The P/E ratio can also standardize the value of $1 ofearnings throughout the stock market. In theory, by taking the median of P/Eratios over a period of several years, one could formulate something of astandardized P/E ratio, which could then be seen as a benchmark and used toindicate whether a stock is worth buying.


N/A Meaning

A P/E ratio of N/A means the ratio is unavailable forthat company's stock. A company can have a P/E ratio of N/A if it's newlylisted on the stock exchange and has not yet reported earnings, such as with aninitial public offering. It could also mean a company has zero or negativeearnings.




P/E vs. Earnings Yield
The inverse of the P/E ratio is the earnings yield (which canbe thought of as the earnings/price ratio). The earnings yield is the EPSdivided by the stock price, expressed as a percentage.
If Stock A is trading at $10, and its EPS for the pastyear is 50 cents (TTM), it has a P/E of 20 (i.e., $10 / 50 cents) and anearnings yield of 5% (50 cents / $10). If Stock B is trading at $20 and its EPS(TTM) is $2, it has a P/E of 10 (i.e., $20 / $2) and an earnings yield of10% ($2 / $20).
The earnings yield is not as widely used asthe P/E ratio. Earnings yields are useful if you're concerned about therate of return on investment. For equity investors who earn periodic investmentincome, this may be a secondary concern. This is why many investors may prefervalue-based measures like the P/E ratio or stocks.
The earnings yield is also helpful when a company haszero or negative earnings. Since this is common among high-tech, high-growth,or startup companies, EPS will be negative and listed as an undefined P/E ratio(denoted as N/A). If a company has negative earnings, however, it would have anegative earnings yield, which can be used for comparison.




P/E vs. PEG Ratio
A P/E ratio, even one calculated using aforward earnings estimate, doesn’t always tell you whether the P/E isappropriate for the company’s expected growth rate. To address this,investors turn to the price/earnings-to-growth ratio, or PEG.
The PEG ratio measures the relationship between theprice/earnings ratio and earnings growth to give investors a completepicture. Investors use it to see if a stock’sprice is overvalued or undervalued by analyzing earnings and theexpected growth rate for the company. The PEG ratio is calculated as acompany’s trailing price-to-earnings (P/E) ratio divided by its earnings growthrate for a given period.
Since it’s based on both trailing earnings and futureearnings growth, PEG is often viewed as more informative than the P/E ratio.For example, a low P/E ratio could suggest a stock is undervalued and worthbuying. However, including the company’s growth rate to get its PEG ratio mighttell a different story. PEG ratios can be termed “trailing” if using historicalgrowth rates or “forward” if using projected growth rates.
Although earnings growth rates can vary amongdifferent sectors, a stock with a PEG of less than one is typicallyconsidered undervalued because its price is low relative to itsexpected earnings growth. A PEG greater than one might be consideredovervalued because it suggests the stock price is too high relative to thecompany’s expected earnings growth.6


Absolute vs. Relative P/E
Analysts also distinguish between absolute P/Eand relative P/E ratios intheir analyses.


Absolute P/E
The numerator of this ratio is usually the currentstock price, and the denominator may be the trailing EPS (TTM), theestimated EPS for the next 12 months (forward P/E), or a mix of the trailingEPS of the last two quarters and the forward P/E for the next two quarters.
When distinguishing absolute P/E from relative P/E,remember that absolute P/E represents the P/E of the current period. Forexample, if the stock price today is $100 and the TTM earnings are $2 pershare, the P/E is 50 = ($100 / $2).


Relative P/E
The relative P/E comparesthe absolute P/E to a benchmark or a range of past P/Es over a relevant period,such as the past 10 years. The relative P/E shows what portion or percentage ofthe past P/Es that the current P/E has reached. The relative P/E usually comparesthe current P/E value with the highest value of the range. Investors might alsocompare the current P/E to the bottom side of the range, measuring how closethe current P/E is to the historic low.
The relative P/E will have a value below 100% if thecurrent P/E is lower than the past value (whether the past is high or low). Ifthe relative P/E measure is 100% or more, this tells investors that the currentP/E has reached or surpassed the past value.


Limitations of Using the P/E Ratio
Like any other fundamental metric, theprice-to-earnings ratio comes with a few limitations that areimportant to understand. Companies that aren't profitable and have noearnings—or negative earnings per share—pose a challenge for calculating P/E.Views among analysts vary about how to deal with this. Some say there is anegative P/E, others assign a P/E of 0, while most just say the P/E doesn'texist (N/A) until a company becomes profitable.
A main limitation of using P/E ratios is for comparingthe P/E ratios of companies from varied sectors. Companies' valuation andgrowth rates often vary wildly between industries because of how and when thefirms earn their money.
As such, one should only use P/E as a comparative toolwhen considering companies in the same sector because this is the only kindthat will provide worthwhile results. For example, comparing the P/E ratios of a retail company and the P/E of an oil and gas drilling company could suggest one is the superior investment, but that's not acogent conclusion. An individual company’s high P/E ratio, for example, wouldbe less cause for concern when the entire sector has high P/E ratios.


Other P/E Considerations
Because a company’s debt can affect both share priceand earnings, leverage can skewP/E ratios as well. For example, suppose two similar companies differ in thedebt they hold. The firm with more debt will likely have a lower P/E value thanthe one with less debt. However, if the business is solid, the one with moredebt could have higher earnings because of the risks it has taken.
Another critical limitation of price-to-earnings ratioslies within the formula for calculating P/E. P/E ratios rely on accuratelypresenting the market value of shares and earnings per share estimates. Themarket determines the prices of shares available in many places. However, thesource of earnings information is the company itself. Thus, it’s possible itcould be manipulated, so analysts and investors have to trust the company’sofficers to provide genuine information. The stock will be considered riskierand less valuable if that trust is broken.
To reduce these risks, the P/E ratio is only onemeasurement analyst's review. If a company were to manipulate its resultsintentionally, it would be challenging to ensure all the metrics were alignedin how they were changed. That’s why the P/E ratio continues to be a centraldata point when analyzing public companies, though by no means is it the onlyone.


Alternatives to P/E Ratios
While the P/E ratio is a commonly used metric, you canalso use several other alternatives. One such alternative is the price-to-book(P/B) ratio. This ratio compares a company's market value to its book value.The book value represents the company's net asset value according to itsbalance sheet. The P/B ratio is particularly useful for industries withsubstantial tangible assets, and a lower P/B ratio may indicate that the stockis undervalued.
Another alternative is the price-to-sales (P/S) ratiowhich compares a company's stock price to its revenues. This ratio is usefulfor evaluating companies that may not be profitable yet or are in industrieswith volatile earnings. The P/S ratio gives you insight into how much investorsare willing to pay per dollar of sales, making it particularly relevant forstart-ups or tech companies with high growth potential but inconsistentearnings.
The last alternative to consider is the enterprisevalue-to-EBITDA (EV/EBITDA) ratio. It assesses a company's valuation relativeto its earnings before interest, taxes, depreciation, and amortization. TheEV/EBITDA ratio is helpful because it accounts for the company's debt and cashlevels, providing a more holistic view of its valuation compared to the P/Eratio. Investors often use the EV/EBITDA ratio to evaluate companies incapital-intensive industries such as telecommunications or utilities.

What Is a Good Price-to-Earnings Ratio?
The answer depends on the industry. Some industriestend to have higher average price-to-earnings ratios. For example, in February2024, the Communications Services Select Sector Index had a P/E of 17.60, whileit was 29.72 for the Technology Select Sector Index.78 To get a general idea of whether a particular P/Eratio is high or low, compare it to the average P/E of others in its sector,then other sectors and the market.


Is It Better to Have a Higher or Lower P/E Ratio?
Many investors say buying shares in companies with a lowerP/E ratio is better because you are paying less for every dollar of earnings. Alower P/E ratio is like a lower price tag, making it attractive to investorslooking for a bargain. In practice, however, there could be reasons behind acompany’s particular P/E ratio. For instance, if a company has a low P/E ratiobecause its business model is declining, the bargain is an illusion.


What Does a P/E Ratio of 15 Mean?
A P/E ratio of 15 means that the company’s currentmarket value equals 15 times its annual earnings. Put literally, if you were tohypothetically buy 100% of the company’s shares, it would take 15 years for youto earn back your initial investment through the company’s ongoing profits.However, that 15-year estimate would change if the company grows or itsearnings fluctuate.

What Is the Difference Between Forward P/E and Trailing P/E?
The trailing P/E ratio uses earnings per share from thepast 12 months, reflecting historical performance. In contrast, the forward P/Eratio uses projected earnings for the next 12 months, incorporating futureexpectations. Forward P/E is often used to gauge investor sentiment about thecompany's growth prospects while trailing P/E provides a snapshot based onactual past performance.

What Are the Limitationsof the P/E Ratio?
The P/E ratio has several limitations. It doesn'taccount for future earnings growth, can be influenced by accounting practices,and may not be
comparable acrossdifferent industries. It also doesn't consider other financial aspects such asdebt levels, cash flow, or the quality of earnings.


The Bottom Line


The P/E ratio is one of many fundamental financial metrics for evaluating a company. It's calculated by dividing the current market priceof a stock by its earnings per share. It indicates investor expectations,helping to determine if a stock is overvalued or undervalued relative to itsearnings. The P/E ratio helps compare companies within the same industry, likean insurance company to an insurance company or telecom to telecom. It offersinsights into market sentiment and investment prospects. However, it should beused with other financial measures since it doesn't account for future growthprospects, debt levels, or industry-specific factors.



https://www.investopedia.com/terms/p/price-earningsratio.asp
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