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What is the price to earnings ratio?

The price-to-earnings ratio helps investors to decide whether a stock is an expensive or cheap investment. It is calculated by dividing price per share by earnings per share and is one of the most widely used metrics.

Price-to-earnings puts a hard number on how many years of earnings will be required to pay for the purchase price. The p/e ratio does not take account for inflation. The cyclically adjusted price to earnings (CAPE) ratio does adjust for inflation.

Price-to-earnings ratio quick facts

Usage type:

Value

Formula:

price to-earnings ratio = share price / earnings per share.

How to interpret the price-to-earnings ratio

The higher this figure the more expensive the share – the more you are paying for each extra amount of earnings. The ratio is well-suited to comparing companies within the same sector.

The price-to-earnings ratio is the share price expressed as a multiple of earnings. For example, a stock can be said to be trading on a multiple of “23x earnings”.

The p/e ratio can assist in working out how expensive a share is, but it does not control for the different types of companies, from an industrial and business-model perspective.

For example, a growth company may have a high p/e ratio, where shareholders are willing to pay a high price today for low current earnings on the basis of reaping future higher earnings (and an increased return on capital from an expected appreciation of the company share price).

What is the price-to-earnings ratio optimum reading?

FTSE 100 = 16

S&P 500 = 36.94

NASDAQ 100 = 35.86

The historic average p/e of the S&P 500 is 16.

How to use the price-to-earnings ratio

This lesson makes use of the Stockopedia platform’s screener and other tools but these are not essential for successful completion.

Halfords 2 April annual report – go to the financial summary (under accounts if using Stockopedia) to find the data you need.

Calculate price to-earnings ratio: share price / earnings per share.

Find eps normalised in the financial summary (see screenshot below):

Normalised eps excludes the effects of non-recurring, one-off and extraordinary items.

eps (normalised) = 33.9

halfords nomalised eps

Halfords’ share price = 244

halfords share price

To calculate, divide price by earnings per share:

244 / 33.9 = 7.1

Halford price-to-earnings ratio = 7.1