Welcome to the Investors Trading Academy talking glossary of financial terms and events.
Our word of the day is “P/E Ratio”
The P/E ratio is an important indicator as to how the investing market views the health, performance, prospects and investment risk of a public company listed on a stock exchange (a listed company.
The P/E ratio is also a highly complex concept - it's a guide to use alongside other indicators, not an absolute measure to rely on by itself. The P/E ratio is arrived at by dividing the stock or share price by the earnings per share (profit after tax and interest divided by the number of ordinary shares in issue). As earnings per share are a yearly total, the P/E ratio is also an expression of how many years it will take for earnings to cover the stock price investment.
P/E ratios are best viewed over time so that they can be seen as a trend. A steadily increasing P/E ratio is seen by the investors as increasingly speculative because it takes longer for earnings to cover the stock price. Obviously whenever the stock price changes, so does the P/E ratio. More meaningful P/E analysis is conducted by looking at earnings over a period of several years. P/E ratios should also be compared over time, with other company's P/E ratios in the same market sector, and with the market as a whole.
To calculate the P/E ratio:
1. Establish total profit after tax and interest for the past year.
2. Divide this by the number of shares issued.
3. This gives you the earnings per share.
4. Divide the price of the stock or share by the earnings per share.
5. This gives the Price/Earnings or P/E ratio.

By Barry Norman, Investors Trading Academy

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