The price / earnings ratio (PE) is a crude valuation metric which measures a company’s share price in the context of the earnings attributable to that share.
The ratio is calculated by dividing the a company’s share price by its earnings per share (EPS) figure. For example, if a stock trades at £10 per share and its earnings per share are £1 per share, then its PE will be 10 – the share price is 10x earnings.
PE’s can also be used to assess the valuation of a broader market, using the FTSE All Share Index, for instance. But, in isolation, it only provides a one dimensional look at valuation. Due to the importance of other characteristics such as profitability, balance sheet strength, cash generation, long-term growth prospects and the size and sustainability of a company’s market position, a stock with a low PE can be considered expensive and, conversely, a stock with a high PE can be considered cheap. In isolation, therefore, the PE is of only limited use and should be considered alongside a number of other judgements.