P/E ratio: the share price against earnings per share

Definition

The P/E ratio (price to earnings) divides a company’s share price by its net earnings per share. It shows how many years of current earnings the market is paying for a share. It is the most quoted valuation ratio, and the simplest to calculate.

Where to find it in an annual report

Earnings per share, basic and diluted, appear at the bottom of the income statement. Use diluted EPS. For a P/E over the last 12 months, add up the earnings of the last two published half-years. The share price is today’s.

Common thresholds

Value: 12 at most for green, up to 18 for orange, red above. Over the long run, the average P/E of major markets is around 15 to 20. Quality or fast-growing companies often trade at more than 25 times earnings, cyclical or struggling companies at less than 10.

Pitfalls

• Earnings inflated by a one-off item (gain on a disposal) give an artificially low P/E: use recurring earnings when they exist.
• For a cyclical company, a low P/E often appears at the top of the cycle, just before earnings fall, and a high P/E at the bottom.
• The P/E ignores debt: two companies with the same P/E can have very different levels of debt. EV / EBIT takes it into account.
• Trailing, 12-month or forward P/E: data sites do not all show the same one. Compare P/E ratios of the same kind.

Where it does not apply

• Loss-making companies: a negative P/E makes no sense.
• Real estate companies: depreciation of buildings reduces accounting profit, so the share price is rather compared with recurring earnings or with net asset value.
• Companies with earnings close to zero: the P/E becomes huge and says nothing.