Earnings Multiplier
The earnings multiplier is a financial metric that frames a company's current stock price in terms of the company's earnings per share (EPS) of stock, that's simply computed as price per share/earnings per share. The earnings multiplier can be used as a simplified valuation tool with which to compare the relative costliness of the stocks of similar companies. It can likewise help investors judge current stock prices against their historical prices on an earnings-relative basis.
Price-to-Earnings Ratio (P/E Ratio)
Definition
The Price-to-Earnings Ratio (P/E Ratio) is a financial metric that compares a company's current stock price to its earnings per share (EPS). It is calculated as stock price divided by EPS. The P/E Ratio serves as a simplified valuation tool to compare the relative expensiveness of similar companies' stocks. It also helps investors judge the current stock price relative to its historical prices based on earnings.
Origin
The concept of the P/E Ratio originated in the early 20th century as the stock market developed. Investors and analysts needed a simple method to evaluate the value of a company's stock. The earliest use can be traced back to Benjamin Graham and David Dodd's 1934 book, 'Security Analysis,' where they proposed using the P/E Ratio to assess stock value.
Categories and Characteristics
The P/E Ratio is mainly divided into two categories: forward P/E and trailing P/E. The forward P/E is based on expected future EPS and is used to predict a company's future performance; the trailing P/E is based on past EPS and is used to evaluate a company's past performance. The forward P/E is more predictive but also more uncertain; the trailing P/E is more stable but may not reflect future changes.
Specific Cases
Case 1: Suppose Company A has a current stock price of $100 and an EPS of $5, its P/E Ratio would be 100/5=20. This means investors are willing to pay $20 for every $1 of earnings.
Case 2: Company B has a current stock price of $50 and an EPS of $2, its P/E Ratio would be 50/2=25. Although Company B's stock price is lower, its P/E Ratio is higher, indicating that investors have higher expectations for its future growth.
Common Questions
1. Is a higher P/E Ratio better?
Not necessarily. A high P/E Ratio may indicate high market expectations for future growth, but it could also mean the company is currently overvalued.
2. How to choose between forward and trailing P/E Ratios?
Forward P/E is used to predict future performance, while trailing P/E is used to evaluate past performance. The choice depends on the investor's analysis goals.
