I keep hearing about PE on TV. But what is PE?
How is PE calculated?
It’s calculated by dividing the current stock price of a company by the EPS of the company.
For example, if the stock price of a company is $100, and its EPS is $5, the PE is $100 divided by $5, which is 20.
What if a company if not making money? What would be the PE then?
There is no PE for companies that are making a loss.
Is the latest EPS of a company considered for PE ratio?
Yes, usually the PE is calculated using the EPS from the latest result declared by a company. This is also called trailing PE.
However, the PE ratio can also be calculated using the projected or forecast EPS of the company. PE ratio calculated this way is called forward PE.
Why is PE ratio important to me as an investor?
PE is important, because it indicates the price you need to pay for each dollar of the company’s earnings. Based on how it compares with the PE of similar companies, you can tell whether a stock is over-priced or under-priced.
So, what is better – a high PE or a low PE?
There is no general rule, and interpreting PE is a complex task. Also, the PE ratio cannot be used alone by itself – it should be used along with other factors. But that’s a topic for another time…