The P/E Ratio, or Price/Earnings Ratio

The P/E ratio compares a company's current share price to the most recent earnings per share (EPS). So if a share price is £2.50 and the EPS is 25p per share, the P/E ratio is 10. In general terms, provided there are no serious issues with the company's finances, a lower P/E ratio is regarded as prefereable to a higher P/E ratio, since it indicates the company may be cheaper to buy.

However, sometimes companies have a low P/E ratio for a good reason (i.e they are about to go bust), and some classes of share such as banks or utility stocks can fall outside this general rule, due to the structure of their business finances. Estimated or predicted earnings for the next year can be used to produce a 'forward p/e' to identify companies which are likely to become cheaper in the future.

The P/E ratio is perhaps a better indicator of relative value when comparing two companies in the same industry, to establish which may be the better investment. If price/earnings ratio is used alone it can be misleading as an investment indicator, so look for supporting evidence.

What to do if you need more help

If you need more help with your specific commercial loan, mortgage or insurance requirement please speak to a professional financial adviser.

We hope you found this information useful.

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