BUSINESS: The P/E Ratio

When looking for smart long-term stock investments, it’s important to understand a company’s P/E Radio. The P/E Ratio tells you how much faith (or the “valuation”) the public has in a particular company. Thus, the higher the P/E Ratio, the more people think a company will make them money!

However, P/E Radios are not so easy to understand. Let’s try to make the concept very straightforward:

P/E stands for PRICE to EARNINGS. The PRICE is the cost of the stock. The EARNINGS (also called EPS or Earnings Per Share) is the annual profit a company makes divided by the outstanding shares.

Apple Inc. (NASDAQ:AAPL)
Price: $110
Earnings (TTM): $4.83 B
Shares Outstanding: 885 M

EPS (TTM): $5.45
P/E Ratio (TTM): 20.18

For example, as of today, Apple (AAPL) was trading at $110 per share. If you had $110, you could buy 1 share of Apple! Apple has 885M shares outstanding. This means, if you bought 1 share of Apple, there would be 884,999,999 shares owned by the rest of the world! Finally, Apple’s Earnings (TTM) is $4.83B. TTM means “trailing 12-months”. Since Oct 30^th, 2007, Apple has made $4.83 billion!

To find EARNINGS, you then divide Apple's profit ($4.83B) by Apple's outstanding shares (885mm). Apple has EARNINGS of $5.45 per share. That means, for every 1 share of Apple stock, the company made $5.45.

To find the P/E Ratio, divide the cost of 1 share ($110) by the earnings ($5.45). Apple has a P/E Ratio of about 20!

In an ordinary marketplace, stocks typically trade between a 10-25 P/E Ratio. Anything ABOVE 25 could be overpriced, too risky, and maybe not be worth the investment. Likewise, anything BELOW 10 probably won’t make you much money over time. Also, technology stocks (such as Apple) tend to trade at higher than average P/E ratios because the sector is relatively new and there is greater potential for growth.

Happy trading!