Definition of Price Earnings Ratio
Price-earnings ratio or P/E ratio is a price multiple that is used to value a company’s stock or earnings per share.
The formula for price to earnings ratio is:
P/E Ratio = Price per share / Earnings per share
The price of earning is also used as a tool to estimate the target price for taking over a company by an acquirer. The higher the P/E ratio, the more chances are there that the company share price will increase. Also, it is used in business valuation purposes and also for investment purposes where investors assess the market value of the company and decide to invest on the basis of whether the share price is undervalued or overvalued as compared to the current market value.
Example of Price Earnings Ratio:
Let’s assume you want to invest in a company whose P/E ratio is 7.5 times and its EPS in the audited financial statements is $5.2 per share. So the current data can be used to assess that share price should be around
Price per share = P/E ratio x EPS
Price per share = 7.5 times x $5.20 = $39.00