Among the various metrics used to assess the share markets, the P/E ratio is undoubtedly the most common one. The P/E ratio in the share market is the ratio of the current share price vs its earning per share.
American market analysts and investors use P/E ratios to assess the value of a US company's shares and to check if their earning potential justifies their current valuation. Thus, if you're looking to foray into the US stock market, P/E ratios will be helpful when assessing stock options and ascertaining worthy investments.
Now that you know the meaning of a share market P/E ratio, here's an overview of the main types of P/E ratios:
In the US stock market, tech stocks generally have a higher P/E ratio, given the future growth expectations from the holdings. However, high P/E ratios could also mean that the stock is overvalued — especially if the ratio is higher than its peers and own historical P/E ratios.
For instance, the tech-heavy American NASDAQ 100 index recorded a speedy rise in its P/E ratio throughout 2020, since investors were still looking to gain from the pandemic-induced tech boom. However, last year, the index fell 33%, recording its worst performance since 2008.
Similarly, S&P 500's P/E ratio peaked in 2008 (before the economic crash) at 123.79, steadily declining to 13.9 (31.8.2011) in the aftermath. With 20.33 being the median P/E ratio for the stock index, this below-average P/E ratio suggested undervaluation.
Note: There's no one good P/E ratio applicable across sectors and industries. It is a comparison tool, not a benchmark figure applicable to the entire stock market.
A stock's current US market price is listed on the stock exchange against its ticker symbol. You can also find the market value of the shares and their TTM listed on aggregator finance websites. For forward P/E calculations, the EPS of the share is available in the EPS guidance of the company.
Let's say you want to buy Apple shares, currently trading at $145.31 (2.3.2023). The current EPS (TTM) of the share is $6.74. The P/E ratio for the stock would be 21.56. Buying the share suggests you're willing to pay $21.559 for every USD it earns.
While P/E ratios are a great evaluation tool for gauging stock price valuation, it isn't foolproof. So, how reliable is a PE Ratio for measuring a company's investment potential? For starters, P/E ratios don't consider the debt angle and assume that earnings will be consistent for the foreseeable future. Moreover, the earning growth rate — a much more significant metric in assessing price-to-earnings changes — is also missed.
Thus, investors must use other fundamental indicators with P/E ratios to make sound investment decisions. To do so, you can bank on Fi Money. Fi, which works with regulated US brokerages like Alpaca, simplifies the world of US Equities with an easy-to-use interface.
In addition to in-app explainers, Curated Collections (like All-Time Favourites) can help novice investors decide where to place their funds. Experienced investors can deep dive into US Stocks, use numerous filters (such as stock price), and choose from various Blue Chip companies with Trillions in market cap. Moreover, the Fi app has 0% commission, 0 brokerage charges & 0 withdrawal fees.
P/E ratio can be calculated by dividing the current market price of a share by its per-share earnings. This earnings per share value can be a 12-month average or a projection of future earnings.
For example, if a company's stock is trading at $50 per share and its EPS is $5, its P/E ratio would be 10 (50/5 = 10).
There's no defined 'good P/E ratio', as different sectors have different valuation ranges. But, you can determine a good P/E ratio based on the company's or industry's historical standards.
For instance, last year in the US, S&P 500 P/E ratios fluctuated from 20-23. Thus, those below 20 are considered good.
The P/E ratio tells the investor if the stock is currently over or under-valued given its earning potential. Thus, it determines if the stock is fairly priced and has the potential to justify its pricing.
Note: P/E ratio is just one of many factors to consider when evaluating a company's investment potential.
