When you’re looking at EPS you’ll also come across a ratio called the price-earnings ratio.
What is the Price-Earnings Ratio?
The price-earnings ratio is is an important stock market ratio, which compares the current market price of a share in relation to the earnings per share.
The P/E ratio is calculated as follows:
P/E ratio = Market value of share / EPS
How is the Price-Earnings Ratio Used?
Investors use the P/E ratio to assess whether the shares of a company appear to be good value or not.
- A high P/E ratio indicates the stock market expects a strong performance from the company in the future, and that its earnings will keep increasing.
- A low P/E ratio may indicate the market is nervous about a company’s future prospects.
For example, often a technology company will have a very high P/E ratio, even if it doesn’t earn much, as the market believes the company may produce something groundbreaking which will cause its share price to skyrocket in the future.
The investor confidence can be seen when the investors are willing to pay a high multiple of the historical earnings to buy the shares.