P/E is the price / earnings ratio – sometimes called the PER. It is the ratio of a business’s or company’s earnings per share (EPS).

The ratio is used for valuing a company by calculating the company’s share price relative to the company’s per-share earnings. The PER is sometimes also referred to as the ‘earnings multiple’ or the ‘price multiple’.

## Understanding P/E

The price earnings ratio is more easily understood as the pound or dollar amount that an investor would expect to put into a company in order to get one pound or dollar out of that company’s earnings: it essentially shows how much an investor is prepared to pay per pound or dollar earnings. For example, if the P/E multiple of a company is twenty, then an investor is prepared to pay twenty pounds or dollars for one pound or dollar of current earnings.

## Calculating the P/E Ratio

To calculate a company’s P/E ratio we need to know the EPS (earnings per share). The EPS of a company is typically calculated from the last four quarters of operation. When this calculation is employed, it is referred to as the ‘trailing P/E’. We arrive at the trailing P/E by taking the company’s current share value and dividing it by earnings per share over the previous year.

Sometimes analysts create a ‘forward P/E’ or ‘projected P/E’ by estimating the earnings expected over the next four quarters of operation. Another (less usual) way of calculating the forward P/E is to consider the last two quarters of operation and estimates for the next two quarters of operation.

## Expectations of Investment

Under most circumstances, if a company has a high P/E, then investors expect to see high future earnings growth compared to a business that has a lower P/E. It should be noted, though, that if a company has a low P/E, then it may be that that company is undervalued.

If a company is posting losses, or has no earnings, then its P/E will be displayed as ‘N/A’. A negative P/E ratio is technically possible but highly unlikely to be reported. It is widely accepted among the financial community that a negative P/E should be reported as ‘not applicable’.

## Price / Earnings Ratio Limitations

The P/E ratio is a useful insight into whether or not a stock is worth investing in. However, just like any other metric that is used to assess value, the calculation has certain limitations. A P/E ratio for a company may vary across time because of the way that the company earns money may likewise vary. A P/E ratio may, for example, make a telecommunications company look superior to an energy company, but this apparent difference may be due to influences within a sector, as opposed to within the individual companies.

With this in mind, the P/E ratio should only be used in conjunction with other metrics; once understood, it is a useful valuation tool for investors.