On this page is a price-to-earnings calculator or P/E ratio calculator. Enter a company's price per share and annual earnings per share, or total market cap and total earnings in one year to compute a company's PE ratio.
Price to Earnings Ratio Calculator
What is the Price to Earnings Ratio?
The price to earnings ratio is the price paid for a company – or some share of a company – per dollar the company earns. Canonically, it's calculated as the current price for a share of a company divided by the previous 12 months of earnings.
Another way to look at the PE ratio is the earnings payoff length in a steady-state earnings environment. As a quick example, if a company continues to earn $5 per share annually and you need to pay $30 per share, you'd make your money back in earnings in 6 years (and the P/E ratio is currently 6).
The inverse of the price-to-earnings ratio (sometimes – rarely – known as the E/P ratio or earnings-to-price ratio) is generally quoted as a percentage and called the earnings yield. The percentage yield is superior in some situations, for example, comparing to a dividend yield or any interest rate, since it shows a claim on earnings as a percentage of an investment.
Price to Earnings Formula
The price to earnings ratio formula is:
price\ to\ earnings\ ratio=\frac{price}{earnings}Where:
- Price - the current trading price of a share of a company, or alternatively, the total market cap.
- Earnings - the earnings of a share of a company over 12 months.
Limitations on the Price to Earnings Ratio
The price-to-earnings ratio is excellent for a quick check on the relative value of a company compared to peers in a similar group or a company's past. But, as with most, shorthand is limited both in the terms in the ratio and what's omitted.
Limits on Price and Earnings
Price is the amount you have to pay to acquire a company or (usually) share of a company. While equity is an essential part of a company's funding, it's not the only part. Many companies are also funded with preferred equity or various seniorities of debt – which, ultimately, are paid back first in the equity stack before common equity. Enterprise Value factors in debt (net of any cash on the company's balance sheet) and provides a better holistic view of the cost of the "entire" firm.
Earnings are purportedly the final words on how much money a company made per share but aren't necessarily a perfect image. Due to GAAP or IFRS accounting standards, earnings don't necessarily represent the actual money a company is producing – and, to wit, companies almost always pay different tax rates than their reported earnings would imply are owed. EBITDA, or Earnings Before Interest, Taxes, Depreciation, and Amortization, might be a better measure of earnings power – through the EV/EBITDA ratio – that adjusts for capital structure or perhaps you should instead use some form of cash flow or free cash flow.
Limits of PE from Omitted Factors
Young companies tend to either operate at breakeven or a loss in the pursuit of future earnings. That doesn't mean the company is bad, per se, but as a company's value is theoretically the value of a business's future value, the P/E ratio doesn't necessarily capture all economic factors of a business.
Michael Mauboussin's book Expectations Investing captures many of the criticisms of Price to Earnings (and Earnings yield) and inverts the look into what an equity's current trading price implies. (Affiliate link)
You can also get a quick view of Mauboussin's take on intangible investments, which tend to be created from operating expenses such as R&D (research & development) and S&M (sales and marketing). Mauboussin and Dan Callahan released a white paper called One Job: Expectations and the Role of Intangible Investments [PDF] with an overview.
Peter Lynch didn't invent the Price-to-Earnings Growth (or PEG Ratio – developed by Mario Farina in 1969), but he certainly popularized it. In the PEG ratio, the P/E ratio is divided by the percentage earnings growth rate per unit– whether share or the entire firm. Lynch's rule of thumb in his book One Up on Wall Street is that "The P/E ratio of any company that's fairly priced will equal its growth rate." (Affiliate link)
Additionally useful for growth-stage companies are the price to revenue ratio and the Price to Gross Profit ratio. Revenue doesn't lie – it is supposed to match what comes into a company – even if the economics of a firm aren't good. Gross profit might be better since any costs that scale with revenue are ignored – and better to start comparisons between companies further afield from each other, such as marketplaces and software companies.
At the earliest stage companies, there might not be much – if at all – in the form of revenue, so none of these are appropriate. Outside of the public markets, you're likely evaluating team, idea, and total addressable market (TAM) – best of luck!
Limits of PE in the Business Cycle and Rate Environment
Despite discussing the limitations in the ratio, it's important to note there are global factors that affect Price to Earnings ratios.
The first is the business cycle. Near the end of boom times, when labor markets are tightening, earnings should depress as margins compress and employees capture a larger share of revenues. For the opposite reasons, sometimes margins increase as companies capture more and more as a percentage of revenue, reflected by S&M, G&A (or SG&A), or R&D margin. And on an individual company level, growth can't persist forever and needs to eventually drop to background or GDP levels (otherwise, one company would eventually dominate the economy!).
Second is the prevailing interest rate environment. Whether dictated by inflation (or deflation) concerns or other factors, the risk-free interest rate and the prevailing interest rates on debt affect PE ratios. Interest rates change the risks investors are willing to take with their funds and the cost of capital if a company needs to raise. As Warren Buffett jokes, interest rates are like gravity to the price of equities – lower rates mean you will pay higher prices for a given amount of earnings.
The most conservative PE ratio adjustment that is still a ratio is the PE10 or CAPE (Cyclically Adjusted PE Ratio), from Robert Shiller. The PE10 uses the 10-year average inflation-adjusted earnings to value equities – usually indices such as the S&P 500 in the United States, but it has some value as well for the oldest companies. As an ultra-conservative ratio, it does have weaknesses around industry mix (theoretically), as well as legal regimes, business cycle length, taxes, and other factors. Also: keep it far away from growth stocks and early-stage companies (not just those with under 10 years of history).
Ultimately, you need to leave the world of ratios and build a DCF, or discounted cash flow model, to reason about values accounting for every factor. With a DCF, you can build-in sensitivity analysis to various scenarios like a drop (or increase) in growth rates, differences in terminal values, costs of capital, etc. A DCF is only limited by your imagination and the company's surprises... but you do need to factor in your optimism since it's possible to get a DCF to say anything you'd like!
Forward vs. Trailing Price to Earnings Ratio
When looking at a PE ratio, it's important to consider if it's a trailing – or realized – PE ratio, or a Future PE ratio that assumes some earnings yet-to-come.
Forward Price to Earnings
A Forward Price to Earnings ratio is a guess about the PE ratio based upon earnings a company hasn't yet realized. There are a few ways people usually figure these future earnings:
- Analyst estimates – you could use the future earnings per share from a sell-side or buy-side analyst's estimates, or perhaps from a blend of analysts.
- Run-rate – you can use a known historical quantity to model future earnings, perhaps taking the previous quarter's earnings and multiplying by four, or even adjusting for past growth.
- Company projections – many companies will release forward projections with their quarterly or annual reports, which you can use in the PE formula.
- Your projections – you can use your own projections of the future, perhaps supplemented with assumptions from other sources, in the PE ratio.
Of course, while companies are (in theory) valued on future cash earnings, we only know the past and the current price with certainty. There are limitations to any forward earnings projections, so be careful with any Forward PE ratios.
Trailing Price to Earnings
Trailing PE Ratios are the more common PE ratios, and use two known quantities in the last 12 months of earnings and the current price.
Trailing PEs are limited for the reasons in the limitation section... and companies are valued on earnings in the future. Pessimistically, companies can make less or lose money in the future... or grow earnings optimistically.
So don't let the certainty of a trailing PE ratio make you overconfident – beware of the caveats!
