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Home Financial Statement Analysis Price Earnings Ratio (PE Ratio)


Price Earnings Ratio (PE Ratio):


Price earnings ratio (P/E ratio) is the ratio between market price per equity share and earning per share.

The ratio is calculated to make an estimate of appreciation in the value of a share of a company and is widely used by investors to decide whether or not to buy shares in a particular company.

Formula of Price Earnings Ratio:

Following formula is used to calculate price earnings ratio:

Price Earnings Ratio = Market price per equity share / Earnings per share


The market price of a share is $30 and earning per share is $5.

Calculate price earnings ratio.


Price earnings ratio = 30 / 5

= 6

The market value of every one dollar of earning is six times or $6. The ratio is useful in financial forecasting. It also helps in knowing whether the share of a company are under or over valued. For example, if the earning per share of AB limited is $20, its market price $140 and earning ratio of similar companies is 8, it means that the market value of a share of AB Limited should be $160 (i.e., 8 20). The share of AB Limited is, therefore, undervalued in the market by $20. In case the price earnings ratio of similar companies is only 6, the value of the share of AB Limited should have been $120 (i.e., 6 20), thus the share is overvalued by $20.

Significance of Price Earning Ratio:

Price earnings ratio helps the investor in deciding whether to buy or not to buy the shares of a particular company at a particular market price.

Generally, higher the price earning ratio the better it is. If the P/E ratio falls, the management should look into the causes that have resulted into the fall of this ratio.

You may also be interested in other articles from "financial statement analysis" chapter:

  1. Horizontal and Vertical Analysis
  2. Ratios Analysis
  3. Horizontal Analysis or Trend Analysis
  4. Trend Percentage
  5. Vertical Analysis
  6. Accounting Ratios Definition, Advantages, Classification and Limitations:
  7. Gross profit ratio
  8. Net profit ratio
  9. Operating ratio
  10. Expense ratio
  11. Return on shareholders investment or net worth
  12. Return on equity capital
  13. Return on capital employed (ROCE) Ratio
  14. Dividend yield ratio
  15. Dividend payout ratio
  16. Earnings Per Share (EPS) Ratio
  17. Price earning ratio
  18. Current ratio
  19. Liquid/Acid test/Quick ratio
  20. Inventory/Stock turnover ratio
  21. Debtors/Receivables turnover ratio
  22. Average collection period
  23. Creditors/Payable turnover ratio
  24. Working capital turnover ratio
  25. Fixed assets turnover ratio
  26. Over and under trading
  27. Debt-to-equity ratio
  28. Proprietary or Equity ratio
  29. Ratio of fixed assets to shareholders funds
  30. Ratio of current assets to shareholders funds
  31. Interest coverage ratio
  32. Capital gearing ratio
  33. Over and under capitalization
  34. Financial-Accounting- Ratios Formulas
  35. Limitations of Financial Statement Analysis


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