The price-to-earnings ratio (P/E ratio) is a common and quick way to assess the value of a company. The P/E ratio is calculated using the following formula:
The P/E ratio is a quick and easy tool for investors to compare the value of companies in different industries or of different sizes, or to quickly compare a single company to its previous performance over a specified time period. A high P/E ratio might indicate that the company is over-valued while a low P/E ratio might indicate that it is undervalued.
There are two main types of P/E ratios: Trailing and forward. The trailing P/E ratio looks at actual data in the past, usually over the last 12 months, while the forward P/E ratio looks at projected data, specifically projected earnings per share (EPS). While the forward P/E ratio does provide some insight into the organization’s projected success, it is assuming that success will occur. For this reason, the trailing P/E ratio tends to be the most preferred of the two, as it looks at actual performance data.