The P/E ratio (price-to-earnings ratio) of a stock is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share. It is a financial ratio used for valuation. P/E ratio shows current investor demand for a company share. P/E ratio has units of years. P/E is the most popular metric of stock analysis. The reciprocal of the PE ratio is known as the earnings yield.
There are various P/E ratios, all defined as:
P/E ratio =
PRICE PER SHARE ANNUAL EARNINGS PER SHARE
Earnings per share (EPS) are the earnings returned on the initial investment amount. Calculating EPS
EPS(basic formula) EPS= Profit / Weighted average common share EPS(net income formula) EPS= Net Income/Weighted average common share EPS(continuing operations formula) EPS= Income from continuing operations / Weighted average common share
Example: The market price of a share is $30 and earning per share is $5.
Calculation:
Price earnings ratio = 30 / 5 = 6
The P/E ratio can alternatively be calculated by dividing the company's market capitalization by its total annual earnings. For example, if a stock is trading at $24 and the earnings per share for the most recent 12 month period is $3, then stock A has a P/E ratio of 24/3 or 8.
Is derived from the dividend discount model. Constant growth dividend discount model, P = D / r-g Where, D = E(1-b)
=> P = E(1-b) / r-g
=> P/E = (1-b) / r-g
Where, (1-b)= dividend payout ratio b= ploughback ratio r= required rate of return g= expected growth rate Growth rate Internal growth rate, g= RoA * b / 1-(RoA * b ) where, RoA= m * Asset turnover m= net profit margin asset turnover= sales/asset
External growth rate, g= RoE * b / 1-(RoE * b ) Where, RoE= m * assets/equity * asset turnover m= net profit margin asset turnover= sales/asset
P/E ratio & b: an increase in b leads to increase in P/E. P/E