What is a P/E ratio? - The Basics For New Investors

**CrossProfit** Sat May 20, 2006 6:00 am

What is a P/E ratio? - The Basics For New Investors
ratio > n. relation one quantity has to another, as expressed by number of times one can be divided by the other; proportion.

PE ratio is also known as price/earnings ratio or simply PE. A stock that trades at a PE of 12 is a stock that is traded at 12 times the earnings per share. For example if a share in company X earned $1.00 over a period of twelve months and the stock is trading at $15.00 a share, then the PE ratio is 15.

The first item to deal with is the word 'earned'. All listed companies are required to report their earnings. Companies are required to file detailed reports covering many aspects of their business. However for now, we will concern ourselves solely with the earnings report.

There are many different kinds of earnings! A company can sell part of its business for either a profit or a loss and this will either increase or decrease the earnings per share. A company can win or lose a legal action and this too will change the earnings per share. The possibilities are endless.... Most analysts will scrutinize the earnings report and classify earnings into two categories. The first category is operating earnings (also known as net income, regular earnings, net earnings, etc. Each one of these terms can have a totally different meaning as well.) The second category is onetime earnings (also known as extraordinary income/gain/profit/charge/loss.)

It is generally accepted to exclude all onetime items when calculating the PE. The only 'fly in the ointment' is how the analyst team classified the earnings!

The second item to deal with is the word 'period'. The three most common ways of defining the twelve month period are historical, projected and combination. Historical means the actual earnings as reported by the company for the preceding twelve months as per the latest report. (This is usually filed every three months). Projected means: the estimated earnings for the next twelve months, starting from the date of the last report of actual earnings. Combination can mean the average of the historical and projected combined (historical + projected / 2). This type of combination is seldom used. The more common form of combination is the actual earnings as reported for the preceding six months together with the estimated earnings for the next six months.

Conclusion

Newsletter A can list a PE of 16 for company X and newsletter B can list a PE of 13 for the same company and they are both correct and accurate!

Posted by CrossProfit.com from CrossProfit website - "The Basics"
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