Price-to-earnings ratio

The price of a share divided by the earnings attributable to it. An equity multiple, because both parts are measured after interest has been paid.

Example

A share at 40 earning 2.50 trades at 16.0 times earnings, which is the same thing as a 6.25% earnings yield.

Important

Borrowing changes it without changing the underlying business, so a lower ratio can simply mean more debt. A screen run on this ratio alone systematically favours the more indebted company.

Related terms

  • Earnings yield — Earnings divided by price - the price-to-earnings ratio turned upside down. Expresses a share's price as a return, so it can be compared with other uses of the same money.
  • Equity value — The value of the owners' share alone - enterprise value less net debt. What a buyer of the shares is actually paying for.
  • EV/EBITDA — Enterprise value divided by EBITDA - the most common multiple for comparing whole businesses, because both parts are calculated before the effects of borrowing.

Lessons that explain it

  • Appraising one company: the figures, and the growth already in the price — A practical pass over one listed business - what it earns, what it owes, what cash it keeps, and what the current price is already assuming. (14 min)
  • Comparables and multiples: what the market is already paying — A multiple is not a shortcut past valuation. It is somebody else's valuation, compressed into one number, and using it means inheriting every assumption inside it. (12 min)
  • Work backwards: what would have to be true to justify this price? — Rather than producing your own valuation and comparing it with the price, take the price as given and solve for the growth or margins it assumes. Then judge whether those assumptions are plausible. (11 min)

All 578 terms in the Investing glossary