Price-to-earnings ratio

Price per share over earnings per share: what the market pays for a unit of profit. A high one can mean growth is expected or earnings are depressed, and it is meaningless as earnings near zero.

Where you will meet it

Price-to-earnings ratio appears in 26 learning outcomes on the CFA syllabus. A few of them:

• Outline the main families of equity valuation model and what each gains or gives up
  CFA Level I · Equity Investments

  “Multiplier models apply a ratio such as P/E or EV/EBITDA from peers or history; they are quick and market-based, but only say whether a share is cheap relative to something that may itself be mispriced.”

• Work out PVGO (the present value of what future growth opportunities are worth) and the share of the leading P/E it accounts for, and explain both
  CFA Level II · Equities

  “Dividing by E1 splits the leading P/E into 1 ÷ r, the no-growth multiple, plus PVGO ÷ E1, the part owed to growth opportunities.”

• Set out how valuation multiples change over the business cycle
  CFA Level II · Portfolio Construction

  “Valuation multiples such as the price-to-earnings ratio are themselves cyclical.”

• Set out how an equity risk premium can be estimated from past data or from forward-looking inputs
  CFA Level II · Corporate Finance

  “Forward-looking estimates include surveys, the Gordon growth model (forward dividend yield + expected long-term growth − government bond yield) and the supply-side model, which builds the expected return from expected inflation, real EPS growth, any change in the P/E ratio and the income return, then subtracts the bond yield.”

Practise it

• Today's practice question One question, with every wrong option explained.
• Free Level I diagnostic test Twelve questions that show which topics to start with.
• Free finance calculators Check your arithmetic on the exam's core formulas.

All terms beginning with P · Glossary