From the course: Running a Profitable Business: Understanding Financial Ratios
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Price-earnings ratio
From the course: Running a Profitable Business: Understanding Financial Ratios
Price-earnings ratio
- Let's talk about another class of financial ratios, ratios that involve comparing a financial statement number with a market value number. And the primary ratio in this category is the P/E ratio, the price-to-earnings ratio. This is one of the most famous ratios of all time. It's a connection between the amount of net income that a company is generating this year, its earnings, and the price, or the market value that people are willing to pay for that company. And as you would think, if a company has higher growth prospects in the future, the price-to-earnings ratio is going to be higher because of this reason. When you buy a company, are you buying its past or are you buying its future? You're buying the future. And if the future looks very large compared to the earnings right now, you're going to have to pay a premium to buy that company. So higher price earnings ratio reflects market expectations that earnings,…
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