Series 7: 9.4.1.5.3.4. Price/Earnings Ratio

9.4.1.5.3.4. Price/Earnings Ratio

The price/earnings (P/E) ratio measures the price investors are willing to pay for a stock per dollar of earnings. It is used by analysts to determine whether a stock is over- or undervalued. Stocks with higher P/E ratios indicate that investors expect higher future profits and are willing to pay a high price for these expectations. Stocks with high P/E ratios tend to be riskier investments. Stocks with lower P/E ratios are often called value stocks, whereas stocks with high P/E ratios are called growth stocks.

The P/E ratio can also be calculated by taking the market capitalization of a company and dividing it by the company’s net income. The market capitalization is equal to the stock price