ArtsAutosBooksBusinessEducationEntertainmentFamilyFashionFoodGamesGenderHealthHolidaysHomeHubPagesPersonal FinancePetsPoliticsReligionSportsTechnologyTravel

What is price earnings ratio? Meaning and Significance

Updated on April 19, 2013
Source

Video on Price Earnings Ratio:

What is Price Earnings Ratio?

Price Earnings Ratio, is a simple common financial formula used by value and conservative investors. Benjamin Graham and Warren Buffett, famous investors and analysts, were strong proponents of this technical term. Price Earnings Ratio, helps to find whether the current stock, sector or market is overvalued or undervalued.

This formula for Price Earnings ratio is simply the current price of the stock divided by annual earnings of the company. It is always good to compare two stocks in the same industry. For instance, AGNC, mortgage REIT, stock price is $32.16. Annual earnings per share is $6.40. Thus, price earnings ratio is 32.16/6.40= 5.02. Another stock in the same industry is IVR. Stock price is $18.85 and annual earnings per share is $3.15. Thus, price earnings ratio is 18.85/3.15 = 5.99. Hence, even though the stock price of AGNC is high as compared to IVR, it is relatively cheaper when earnings per share is taken into consideration.

Meaning and Significance. Price Earnings Ratio is dependent on time of investing. Certain periods, this ratio tends to be low and other times, it can go up. Just before the burst of bubble of dot com companies, price earnings ratio was astronomically high. Hence, it is a good financial indicator of the market conditions and act as good predictor of the dangers ahead. It is always good to understand these simple financial terms as it can help us to save our savings or even retirement income from a sudden collapse in market.

In general, price earning ratio of 0-5 is low whereas above 20 is high. Moderate price earning ratio is somewhere between 5-20. However, the PE ratio depends on the time of investing, sector and industry. The average ratio might be completely different for one industry like mortgage REITs as compared to technology stocks.

Conservative investors tend to focus on stocks with low price earnings ratio. However, low price earnings ratio can also indicate that investors have less confidence in this stock and the growth prospects of the stocks are low.

Full time investors who are looking for significant growth and high returns, tend to find stocks with high price earnings ratio as good candidates. High PE ratio indicates that market is willing to pay higher price for small earnings of this company. This implies that future confidence in earnings is high. Companies like AAPL, technology stock, can have very high price earnings ratio during the growth period. So, sometimes there is a hidden goldmine in companies with high PE ratios too.

In Summary, there is no right or optimum price earning ratio. It is a financial term which provides us some clues and helps us in analysis. It is commonly used by analysts and value investors to compare stocks and sectors. It is good to understand financial ratios as it helps us to take a good decision. Investment involves risk and it is important to have proper guidance before starting on this journey.

4 out of 5 stars from 1 rating of Price Earning Ratio important to investing
working

This website uses cookies

As a user in the EEA, your approval is needed on a few things. To provide a better website experience, hubpages.com uses cookies (and other similar technologies) and may collect, process, and share personal data. Please choose which areas of our service you consent to our doing so.

For more information on managing or withdrawing consents and how we handle data, visit our Privacy Policy at: https://corp.maven.io/privacy-policy

Show Details
Necessary
HubPages Device IDThis is used to identify particular browsers or devices when the access the service, and is used for security reasons.
LoginThis is necessary to sign in to the HubPages Service.
Google RecaptchaThis is used to prevent bots and spam. (Privacy Policy)
AkismetThis is used to detect comment spam. (Privacy Policy)
HubPages Google AnalyticsThis is used to provide data on traffic to our website, all personally identifyable data is anonymized. (Privacy Policy)
HubPages Traffic PixelThis is used to collect data on traffic to articles and other pages on our site. Unless you are signed in to a HubPages account, all personally identifiable information is anonymized.
Amazon Web ServicesThis is a cloud services platform that we used to host our service. (Privacy Policy)
CloudflareThis is a cloud CDN service that we use to efficiently deliver files required for our service to operate such as javascript, cascading style sheets, images, and videos. (Privacy Policy)
Google Hosted LibrariesJavascript software libraries such as jQuery are loaded at endpoints on the googleapis.com or gstatic.com domains, for performance and efficiency reasons. (Privacy Policy)
Features
Google Custom SearchThis is feature allows you to search the site. (Privacy Policy)
Google MapsSome articles have Google Maps embedded in them. (Privacy Policy)
Google ChartsThis is used to display charts and graphs on articles and the author center. (Privacy Policy)
Google AdSense Host APIThis service allows you to sign up for or associate a Google AdSense account with HubPages, so that you can earn money from ads on your articles. No data is shared unless you engage with this feature. (Privacy Policy)
Google YouTubeSome articles have YouTube videos embedded in them. (Privacy Policy)
VimeoSome articles have Vimeo videos embedded in them. (Privacy Policy)
PaypalThis is used for a registered author who enrolls in the HubPages Earnings program and requests to be paid via PayPal. No data is shared with Paypal unless you engage with this feature. (Privacy Policy)
Facebook LoginYou can use this to streamline signing up for, or signing in to your Hubpages account. No data is shared with Facebook unless you engage with this feature. (Privacy Policy)
MavenThis supports the Maven widget and search functionality. (Privacy Policy)
Marketing
Google AdSenseThis is an ad network. (Privacy Policy)
Google DoubleClickGoogle provides ad serving technology and runs an ad network. (Privacy Policy)
Index ExchangeThis is an ad network. (Privacy Policy)
SovrnThis is an ad network. (Privacy Policy)
Facebook AdsThis is an ad network. (Privacy Policy)
Amazon Unified Ad MarketplaceThis is an ad network. (Privacy Policy)
AppNexusThis is an ad network. (Privacy Policy)
OpenxThis is an ad network. (Privacy Policy)
Rubicon ProjectThis is an ad network. (Privacy Policy)
TripleLiftThis is an ad network. (Privacy Policy)
Say MediaWe partner with Say Media to deliver ad campaigns on our sites. (Privacy Policy)
Remarketing PixelsWe may use remarketing pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to advertise the HubPages Service to people that have visited our sites.
Conversion Tracking PixelsWe may use conversion tracking pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to identify when an advertisement has successfully resulted in the desired action, such as signing up for the HubPages Service or publishing an article on the HubPages Service.
Statistics
Author Google AnalyticsThis is used to provide traffic data and reports to the authors of articles on the HubPages Service. (Privacy Policy)
ComscoreComScore is a media measurement and analytics company providing marketing data and analytics to enterprises, media and advertising agencies, and publishers. Non-consent will result in ComScore only processing obfuscated personal data. (Privacy Policy)
Amazon Tracking PixelSome articles display amazon products as part of the Amazon Affiliate program, this pixel provides traffic statistics for those products (Privacy Policy)
ClickscoThis is a data management platform studying reader behavior (Privacy Policy)