Pe Ratio

Price Earnings Ratio: Definition

PE = Market Price per Share / Earnings per Share

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There are a number of variants on the basic PE ratio in use. They are based upon how the price and the earnings are defined.

Price:

•  is usually the current price (though some like to use average price over last 6 months or year)

EPS:

•  Time variants: EPS in most recent financial year (current), EPS in most recent four quarters (trailing), EPS expected in next fiscal year or next four quartes (both called forward) or EPS in some future year

•  Primary, diluted or partially diluted

•  Before or after extraordinary items

•  Measured using different accounting rules (options expensed or not, pension fund income counted or not…)

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Characteristic 1: Skewed Distributions PE ratios for US companies in January 2012

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Characteristic 2: Biased Samples PE ratios in January 2012

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Characteristic 3: Across Markets PE Ratios: US, Europe, Japan and Emerging Markets – January 2012

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PE Ratio: Understanding the Fundamentals

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To understand the fundamentals, start with a basic equity discounted cash flow model. With a stable growth dividend discount model:

P0 = DPS1 r − gn

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Dividing both sides by the current earnings per share or forward EPS:

Current EPS

Forward EPS

P0 Payout Ratio * (1 + g n ) = PE = EPS0 r-gn

P0 Payout Ratio = PE = EPS1 r-g n

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If this had been a FCFE Model,

P0 = FCFE1 r − gn

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P0 (FCFE/Earnings) * (1+ g n ) = PE = EPS0 r-g n

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PE Ratio and Fundamentals

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Proposition: Other things held equal, higher growth firms will have higher PE ratios than lower growth firms.

Proposition: Other things held...