What Is “P/E Ratio”
The P/E ratio is the ratio of the current stock price to last year’s earnings. It is also known as the price-to-earnings ratio. The figure can be drawn from the firm’s financial statements, typically, the most recent past accounting earnings.
Examples of P/E Ratio:
Based on the closing price 2/9/18
Apple Inc (NASD: AAPL)- 16.09
You pay $16.09 per share per $1 of current earnings.
Amazon.com (NASD: AMZN)
You’re paying $296.81 per share per $1 of current earnings.
Amazon has historically had a high P/E ratio and been among one of the top performing Nasdaq stocks in the market.
Some analysts will tell you that investing in stocks with a low P/E ratio is a better bargain than ones with a higher one. However, if you listened to that line of thinking you would have missed of some of the biggest stock gainers over the last few years.
P/E Ratio Varies Across Sectors
Bank stocks typically have low P/E ratios. For example, Bank of America (NYSE: BAC), JP Morgan (NYSE: JPM), Wells Fargo (NYSE: WFC), and Citigroup (NYSE: C) all have P/E ratios below 20.
However, there can be large disparities even among sectors. For example, Netflix (NASD: NFLX) has a P/E ratio of nearly 200. While, other companies in the space like: Dish Network (NASD: DISH), CBS Corporation (NYSE: CBS), and Charter Communications (NASD: CHTR) have P/E ratios nearly ten times as small.
Does P/E Ratio Matter?
Using the P/E ratio alone to make an investment decision doesn’t make a whole lot of sense. As we’ve seen, some of the best stocks to own over the last decade, Netflix and Amazon, have boasted some of the highest ones.
Investors could use it to compare companies in the same sector. But take it with a grain of salt. Depending on what stage a company is in, whether its trying to expand and grow. If the number is high, investors have expectations that growth will be greater in the future. In addition, companies that are posting losses do not have a P/E ratio.
Overall, its good to know but if you are a trader that number will not help you. An investor may or may not find value in using the price-earnings ratio.