Value Line University

Price/Earnings Ratios

Earnings per share is the amount of a company's profit or net income after taxes attributable to each of its common shares outstanding. The price of each share is its value based on the last public sale of a share. The ratio between them, or the price divided by the earnings, is the stock's P/E.

For example, if ABC Corp's share price was $22.50 and its earnings per share $1.25, the P/E ratio would be 18. If its earnings were $1.50 and its price $22.50, then its P/E would be 15. And if its earnings were $1 and the price $22.50, its P/E would be 22.5.

There is no "right" or "wrong" P/E, but there is a current median P/E, or midpoint of the ratios of all the stocks Value Line tracks for The Value Line Investment Survey. The median is shown each week on the front cover of the Summary & Index section. On February 25, 2000, for example, that median was 13.7. That means that half of all stocks in The Value Line Investment Survey had a higher P/E and half had a lower P/E as of that particular date by that median.

In general, buyers will pay higher prices and accept a higher P/E to own the stock of a company whose earnings they believe will grow at a faster rate than those of the average company. In fact, one of the fascinating things about investors is that they are often willing to pay high prices for certain "hot" stocks that have low, or even no, earnings on the anticipation that they will be money makers in the future. The reverse is also true.