P/E - Pricing-Earnings
The P/E is a ratio, also known as a multiple. This type of number gives you an idea of whether a stock is considered expensive or cheap. Since P/E stands for Price-Earnings, this number tells you how much you will pay for a penny's profit after tax if you choose to invest in the stock. A good rule of thumb to remember is that the higher the P/E number for a stock, the more expensive the stock.
Companies often use the P/E ratio when pricing a company. Therefore, you can use the P/E to compare company figures, for example in terms of sales and profits, against the given share price. Here it can be used to compare the stock with other stocks that are in the same sector.
To calculate the P/E ratio, divide the share price by the earnings per share of the company. This is also called Earnings per share, which you can read more about below.
An example of calculating the P/E ratio might look like this: If Company X has put a share up for sale at 200 kroner, while the company has earnings per share purchased of 10 kroner, the calculation for the P/E ratio will look like this:
PE = Share price / Earnings per share = 200 / 10 = 20
This means that Company X has a P/E value of 20. Put another way; you pay 20 crowns for every crown Company X actually earns on the share you bought from it. Although it may sound like a lot that you initially pay 200 crowns for 10 crowns of earnings, this is only the earnings in the first year. Once you have bought the share and own it, you are entitled to a share of the company's earnings for all the years you own that particular share.
However, it is important to understand that the P/E ratio cannot stand alone if you are analyzing a stock and the company behind it. Indeed, the P/E ratio is based on the previous year's earnings, which does not necessarily mean that this is how it will continue. It is therefore important that you include other ratios when analysing a stock - including Earnings per share.