Price to earning ratio
, is one of a large family of valuation ratios
which are intended to help investor
s make sound decisions.
The fundamental concept of PE ratios is that the shares
in the same industry
should, in the absence of easily understood reasons to the contrary, trade for roughly the same price.
Intuitively this make sense. Consider for example two computer software
services firms, with roughly identical financial
details; that is, earnings
, outstanding debt
An astute investor, using PE
, might notice that the market was undervaluing
one firm, or perhaps overvaluing
Price to earnings
can be calculated by dividing a company's market cap
by its total earnings, or else dividing its share price
by its earnings per share
A final but perhaps obvious
note about PE ratios; this is a meaningless concept for firms without earnings.
In this case investors must turn to other valuation ratios such as Price to book
or Price to sales