Chapter 7, Problem 18PROB

Summary Introduction

PE ratio of the stock is between 28 and 30 from the past 15 years and its earnings per share is $4.

Price to earnings ratio (P/E ratio) or earnings multiplier is another form of valuing a company. It is a relative way of analyzing the value of a stock. P/E ratio is calculated by dividing the current market price of the stock by its earnings per share. Higher P/E ratio indicates that investors are willing to pay more for each dollar of earnings and vice-versa. P/E ratio tells us how long it will take for the investors to recover its investment. A high P/E ratio means it will take longer to recover their amount invested and a low P/E ratio means tat the investment will be recovered faster. Therefore, it is a measure of the payback period of the investment. Moreover, a company with low PE is undervalued and with market correction, the stock price is expected to rise in the future. Similarly, for a very high P/E stocks, price might fall with the market correction, as it is overvalued.

$PE=\frac{\text{Current Price}}{\text{Earnings per share}}$