I'm too ashamed to ask, but what is a p/e ratio?

Learn how to use the price/earnings ratio (abbreviated "p/e ratio") , a helpful place for investors to start when determining a company's worth

Too embarrassed to ask: what is a P/E ratio? - YouTube Too embarrassed to ask: what is a P/E ratio? - YouTube Watch On If you are thinking about investing in a company's shares, one of the first things you'll want to know is: Does the price I'm paying represent good value?

The price/earnings ratio, or p/e ratio for short, is one of the first approaches you'll probably come across when answering that question.

The price/earnings (p/e) ratio is a popular metric used by investors to assess how cheap a share is. It's one of the most basic methods of valuation available, and for good reason. All you have to do is divide the share price by the earnings (profits) per share. A company would therefore have a p/e ratio of ten if its share price was fifty pounds and its earnings per share (EPS) was five pounds.

A forward p/e ratio is one that is based on projected earnings, whereas a trailing p/e ratio is one that is based on past earnings. As in "Acme Widgets is trading on a multiple of ten times its earnings," P/E ratios are also occasionally referred to as "multiples."

A p/e of ten essentially indicates that you are paying 10 for every unit of earnings, whereas a p/e of 20 would indicate that you are paying 20 for every unit of earnings. Therefore, it is obvious that, in theory, the share is less expensive the lower the p/e. A lower p/e does not, however, always indicate that a business offers good value. Investors may not truly believe that current earning levels can be sustained if they are only willing to pay five for every one of current earnings, for example. Rather, there might be significant issues that prevent further expansion or result in declining earnings.

High-flying tech stocks, for instance, usually trade on relatively high p/e ratios. In contrast, those trading on higher p/e ratios may appear expensive but may actually be expected to grow exceptionally strongly.

Additionally, keep in mind that certain industrieshousebuilding and mining, for instanceare highly cyclical. They typically trade on high p/e at low points in the economic cycle (when they might be losing money) and low multiples at high points (when they are extremely profitable). One method to try to adjust for this is the cyclically adjusted price/earnings ratio (also called the Cape ratio, or Shiller p/e), which averages earnings over ten years.