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Understanding the P/E ratio

Understanding the P/E ratio

by Asha Nur -
Number of replies: 1

The price-to-earnings ratio (P/E) is one of the most widely used tools by which investors and analysts determine a stock's relative valuation. The P/E ratio helps one determine whether a stock is overvalued or undervalued. A company's P/E can also be benchmarked against other stocks in the same industry or against the broader market, such as the S&P 500 Index.

Sometimes, analysts are interested in long-term valuation trends and consider the P/E 10 or P/E 30 measures, which average the past 10 or past 30 years of earnings, respectively. These measures are often used when trying to gauge the overall value of a stock index, such as the S&P 500, because these longer-term measures can compensate for changes in the business cycle.

The P/E ratio of the S&P 500 has fluctuated from a low of around 5x (in 1917) to over 120x (in 2009 right before the financial crisis). The long-term average P/E for the S&P 500 is around 16x, meaning that the stocks that make up the index collectively command a premium 16 times greater than their weighted average earnings.

In reply to Asha Nur

Re: Understanding the P/E ratio

by esmot ara -

The ratio is the ratio of price per share to earning per share is commonly known as the price-earning ratio. Much of the real world discussion of stock market valuation concentrates on the firm’s price-earning multiple. Earning a multiplier approach states that the price of the stock is equal to the product of its earnings and a multiplier. It implies that the price of a stock is the product of EPS and P/E multiplier of that stock.


The P/E ratio helps investors determine the market value of a stock as compared to the company's earnings. In short, the P/E ratio shows what the market is willing to pay today for a stock based on its past or future earnings.