A price to earnings (P/E) ratio is a way to measure the value a company’s shares are, effectively the amount of money you are paying for each dollar of its earnings.
You can calculate the P/E ratio by dividing the share price of a company by its annual earnings per share (EPS).
As an example, if a company is currently trading at $14 per share and its earnings per share was $1.12 over the last 12 months, then the P/E ratio for the share would be 14/1.12 = 12.5.
The ratio indicates you are paying 12.5 times the company’s earnings (or $12.50 per each dollar of earnings).
The P/E ratio of a company is often considered in respect to its peers i.e. compare tech company to another tech company or the tech industry (as an index), as the markers for what is considered fair value, overvalued and undervalued will differ from sector to sector.
The P/E ratio is also calculated based on historical data; therefore, it is important to consider this when assessing future earnings and growth potential. It is an important metric in a company’s valuation; however, it is only one of several data points that an investor may consider as part of their overall assessment of a company.
