From the course: Financial Accounting Foundations
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Price-earnings (P/E) ratio
From the course: Financial Accounting Foundations
Price-earnings (P/E) ratio
- Market prices incorporate all kinds of information. For example, the market prices for firms in a given industry include average investor expectations about future earnings growth in that industry, and required rates of return for firms in that industry. This information is summarized in the price, earnings, or PE ratio, and it's defined as price divided by earnings. Hence a clever name price earnings ratio. In this context, price is the market capitalization of the company, the amount it would cost you to buy all the ownership shares. Earnings is just another way to say net income. This PE ratio is an example of a price multiple, exactly analogous to the price per square foot multiple commonly used in estimating the value of residential and commercial real estate. In general, industries in which expected future earnings growth is expected to be high are characterized by high PE ratios like houses in Beverly Hills with high prices per square foot. Conversely, in industries where…
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