Flow of the Article
Price to Earnings Formula
This is one of the most common valuation ratios. No matter what investors look at, PE Multiple is one of the first ratios they check if investing in a company crosses their minds, ever.
This ratio denotes how much market price an investor is paying for a portion of the earnings of the company.
Let’s see the PE Ratio formula –
Explanation of Price to Earnings Formula
In the above ratio, there are two parts.
- The first part is the market price per share. All an investor needs to do is to see how much they need to pay for an equity share of the company. That is the market price per share.
- And the second part is a ratio itself – earnings per share.
If we break down the earnings per share ratio, we get the following –
Earnings per share = (Net Income – Preferred Dividend) / Weighted Average Number of Shares Outstanding
- The numerator is “net income – preferred dividend”. You may wonder why we are deducting the preferred dividend from the net income. It is simply because this is a measure of common shares.
- The denominator is tricky. Here we need to find out the number of common shares outstanding at a different time period and find out the weighted average of that number.
For example, let’s say that a company issues 1000 common shares at the beginning of the year and 1000 again at the middle of the year. If we’re calculating at the end of the year, how would we find out the weighted average?
Here’s what we will do. We will consider first 1000 shares for the entire year and another 1000 shares for a half-annual period. The calculation of weighted average would be = [(1000 * 1) + (1000 * 0.5)] = [1000 + 500] = 1500 shares.
Use of Price to Earnings Formula
There’s no free lunch in business. Every investor wants to know for how much portion of net earnings they are paying the market price for.
- In simple terms, price to earnings ratio decodes how much the investors need to pay for that sum of net earnings of the company.
- Doing this calculation helps the investors decide whether it’s the right to pay the market price for the portion of net earnings they are receiving. If it doesn’t seem enough, they won’t invest.
- A higher Price to Earnings indicates that the company has a strong position in the market and vice versa.
Example of PE Ratio Formula
Let’s take a simple example to find out the PE Ratio.
Solid Stuff Inc. has the following information –
- The market price per share – $25 per share.
- The earnings per share – $10 per share.
Find out the PE Multiple of Solid Stuff Inc.
By using the price to earnings ratio, we get –
- P/E Ratio = Market Price per Share / Earnings per Share
- Or, P/E Ratio = $25 / $10 = 2.5.
Now the investors need to see whether the companies under same industry have the similar PE Ratio or less or more. Depending on that they would be able to understand whether the PE Multiple of Solid Stuff Inc. is good enough for investment.
PE Ratio of Google and Apple
Let us now have a look at the P/E ratios of Google and Apple.
We note that Google has a PE Multiple of 47.42x as compared to Apple PE Multiple of 16.08x. When we compared the two stocks only on the basis of PE Multiple, we find that Google shares are expensive as compared to Apple.
Price to Earnings (PE Ratio) Calculator
You can use the following Price to Earnings (PE Ratio) Calculator.
|Price to Earnings Ratio Formula=||
Price to Earnings (PE Ratio) Formula in Excel (with excel template)
Let us now do the same example above in Excel.
This is very simple. You need to provide the two inputs of Market Price per Share and Earnings per Share.
You can easily calculate the ratio in the template provided.
You can download this price to earnings (PE Ratio) template here – Price to Earnings (PE Ratio) Excel Template
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This has been a guide to Price to Earnings formula, its uses along with practical examples. Here we also provide you with PE Ratio Calculator with downloadable excel template.