P/E

[Michael97]

What is the role of the P/E ratio and how does it help set a value on a stock?

[Beniamin Thomas]

Hi Michael, thanks for the question. 

The P/E ratio is one of the most popular valuation methods applied by financial analysts to determine the stock value. You can often read in the media about how a specific company performed, with the P/E ratio popping up in conversations quite often.  

Similar to earnings per share (EPS) method, the P/E method is very popular due to its simplicity and mass adoption. In essence, you don’t have to be a financial genius to calculate the P/E ratio of the company. It is simply calculated by dividing the current market price per share with the basic EPS to get the P/E ratio. 

For instance, if Facebook trades at $30 per share and its reported EPS is at $3, that makes the P/E ratio at $10. 

Analysts mostly use it to compare companies in the same sector and ultimately determine if the stock is relatively overvalued or undervalued.

It is important to note a difference between the Forward P/E ratio which is based on the estimated earnings per share rather than financial results reported by the company in the past, the values used to calculate the Trailing P/E.