P/E Ratio – Price-to-Earnings Ratio

What Is the Price-to-Earnings Ratio?

The price-to-earnings ratio (P/E) relates a stock's market price for a defined period to the earnings achieved. It is one of the best-known and most widely used ratios in fundamental analysis and indicates how expensive or cheap a stock is valued.

Calculating the P/E Ratio

Concrete Example

Based on current earnings per share, it therefore takes 12.5 years until the current stock price is earned back. This makes it clear: with constant earnings and rising prices, the P/E ratio rises sharply. Conversely, the P/E ratio falls when the stock price falls and/or earnings rise.

Interpretation

Is the P/E Ratio Alone Enough for Stock Selection?

A common objection against relying solely on the P/E ratio is that it becomes meaningless during loss periods. In addition, looking purely at past earnings does not automatically allow conclusions about the future. Past earnings cannot simply be extrapolated. Finally, the P/E ratio can also be influenced by a one-time release of hidden reserves in the balance sheet.

For fundamental stock analysis, it is therefore advisable to also consider other ratios alongside the P/E ratio – such as P/B ratio, ROA, equity ratio and free cashflow.

Earnings Yield – the Inverse of the P/E Ratio

The inverse of the P/E ratio is also interesting: earnings per share divided by the stock price – the so-called earnings yield. Due to investors' pursuit of returns, it often tracks the market interest rate.

This also makes the influence of central banks clear: when a central bank lowers its key interest rate, stock prices rise with a delay, along with P/E values. Rising key interest rates, on the other hand, lead to falling prices and lower P/E ratios.

Alternative P/E Calculations and Industry Comparison

P/E values are often calculated and published as averages for entire industries and indices. The ratio then serves as a benchmark for the general assessment of an industry or index and shows whether the stocks it contains are valued cheaply or expensively.

The long-term average P/E ratio of the DAX over the last 30 years is approximately 19. High-growth industries (e.g. technology) structurally exhibit higher P/E ratios than cyclical industries or financial stocks.

Important: Which Price Is Used?

Particularly important for using the P/E ratio is precisely specifying which stock price it is based on. Possibilities include:

• The current daily price
• The annual average price
• The year-end closing price on the last trading day

Finanzoo's Calculation Method

Finanzoo calculates the P/E ratio exclusively based on actually achieved earnings and does not include expected earnings in the calculation.

When calculating the F-Score, Finanzoo relates the average earnings of the last 3 years, multiplied by a factor derived from empirical studies, to the current stock price. If the deviation from the current price remains below 30%, the stock is considered cheaply valued.

If earnings are negative, the P/E ratio cannot provide meaningful information. In these cases, the price-to-sales ratio (P/S) is used as a fallback ratio for the F-Score.