The P/E ratio calculates a company’s share price in relation to its earnings and helps investors asses a company’s value.
The ratio is calculated by dividing the share price by its earnings per share (or EPS). EPS is calculated by taking the company’s net profit and dividing it by the number of shares it has sold.
For example, if a company has a share price of 200p and an EPS of 40p, its P/E ratio is 5 (200 divided by 40). This means that shares in the company are selling for five times what they earn.
As a general rule, a high P/E ratio suggests there is potential for high growth, which investors may be willing to pay a higher share price for. However, a high P/E ratio could also suggest that shares are overpriced.
P/E ratios can be historic or forward. A historic P/E ratio is based on actual earnings per share over the last year. Forward price-to-earnings ratios are forecasts that predict the EPS for the year ahead.