P/E Ratios are one of the most important metrics used by investors and people following the stock market. Short for ‘Price-to-Earnings Ratio’, this figure can offer understanding into a company’s actual position on the market, and how their earnings relate and compare to other similar businesses.
Because price points vary significantly in the stock market, it can be difficult for investors to understand exactly what they’re looking at without some sort of context. The P/E ratio compares the price of a company’s stock and the profits that they’re actually generating. This is important because stock prices can rise, not based on profits, but because investors expect that they will be profitable in the future. The P/E ratio provides deeper insight into how profitable they are now.
High P/E ratios often point to companies that are overvalued and likely to fall in the near future, while companies with a lower ratio could be undervalued, barely noticed by other investors, yet see significant financial growth. The three most variants of P/E ratio include: