Finance: What is the Price-To-Earnings Ratio?

What is the price-to-earnings ratio? It's the price of the stock divided by its earnings. Stock price: $14; earnings: $1. The P-E ratio then is 14.

College and CareerPersonal Finance
CoursesFinance Concepts
FinanceFinance Definitions
Financial Responsibility
Personal Finance
Finance and EconomicsTerms and Concepts
LanguageEnglish Language
Life SkillsFinance Definitions
Personal Finance
SubjectsFinance and Economics
Terms and ConceptsAccounting
Careers
Company Management
Education
Investing
Stocks

Transcript

00:20

Your sister got the pewter bunny rabbit collection but well

00:24

you can live with that fact that you take the

00:26

thousand shares All right so what on earth do you

00:28

do now What do you do with these things Well

00:31

you have no idea Because you're an orthodontist and you

00:34

have your hands in wet mouths all day Well if

00:37

you'd inherited a truckload of floss well then we totally

00:40

know what to do with it All right Will you

00:42

check out the brokerage reports from morgan stanley on whatever

00:46

dot com it has one hundred million dollars in revenue

00:49

and no earnings no profits Well what Our earnings again

00:54

Oh yeah This revenues from whatever's app sales at a

01:00

buck Each one hundred million of them minus its cost

01:03

of goods sold Well it had to pay fifty million

01:05

bucks to apple and others to get it saps out

01:08

There well then it had a small army of engineers

01:11

and product people on payroll to build The app will

01:13

subtract another thirty million box then it had rent in

01:17

legal expenses and health care insurance and office things like

01:20

computers and app servers All of that added up to

01:23

be twenty million dollars and because of the accounting laws

01:25

you have to subtract it all last year Even though

01:27

the app it lasts a long time i had to

01:29

take it all off the top It had a hundred

01:32

million dollars in revenues and a hundred million dollars in

01:34

expenses and no earnings but it has fifty million shares

01:39

outstanding which when multiplied by twenty bucks a share that's

01:43

What the market's paying for it twenty dollars share It

01:46

gives it a market value of a billion bucks Take

01:49

the shares outstanding kinds of market price to get what

01:52

the company's worth at least according to wall street buying

01:54

and selling the shares Oh it has fifty million dollars

01:56

in cash on the books and no debt so the

01:59

market is valuing the equity of the company at nine

02:04

hundred fifty million dollars meaning it's valuing the earnings power

02:08

Of the company in the future in his hands at

02:11

nine Fifty alright so you wonder forth an honest and

02:15

would be flossed cellar that you are How khun something

02:18

with no profits no earnings be worth a billion dollars

02:24

Well you read through the report which notes that the

02:26

revenues are growing really fast like one hundred percent a

02:29

year and that the market whoever that is believes that

02:34

the company will have two hundred million in revenues next

02:37

year and for hundred million the following year and on

02:40

four hundred million of revenues it will have one hundred

02:43

million dollars in net earnings It'll also produce fifty million

02:48

in cash along the way so in two years it

02:50

will have one hundred million dollars in cash on the

02:52

books and no debt If you go back and think

02:54

about that that you could subtract one hundred million from

02:57

the billion and it's the nine hundred million of equity

03:00

value back we'll get All right So you ponder that

03:05

means that today at a billion dollars i'm paying if

03:08

i buy it at twenty bucks a share i'm paying

03:12

nine times the earnings expected in two years Two years

03:17

From now for the equity value of this company huh

03:22

Well is nine times earnings cheap expensive Attaway frame the

03:26

notion Well the average snp company trades it about sixteen

03:31

times two years out earning something like that But the

03:34

average company is totally different from whatever dot com The

03:37

average company is like a caterpillar Tractors or well pepsi's

03:41

kind of average Wells fargo kind of average Well it's

03:46

a mature company unlike whatever dot com and the people

03:49

who write for shmoop but not mature way No Well

03:52

caterpillar has been around for a century has a stable

03:55

set of fires And you know what are the odds

03:58

People still need tractors to mine food in five years

04:01

You have pretty good odds whereas whatever dot com might

04:05

have totally evaporated by them Yeah well what about revenue

04:09

growth Yep Caterpillars matured gross revenues that only about eight

04:12

percent a year in a good year And it has

04:15

a lot of capital expenses Well every decade or so

04:18

it needs a new smelting plant to smelt engines and

04:21

redo its manufacturing process Tio you know keep up with

04:25

the joneses or rather the blues or chains Oh and

04:29

it pays a small dividend yeah helps well tough company

04:32

to compare with whatever dot com but caterpillar trades at

04:35

about sixteen times thiss years earnings and it'll grow earning

04:38

slowly and you note that it trades at fifteen times

04:42

and extras projected earnings and fourteen times the following year's

04:45

earnings So that's interesting caterpillar trades at a hire multiple

04:51

on two year forward earnings than whatever dot com who

04:53

does that make sense It's nowhere near ist sexy a

04:56

company but it must be the risk the market is

05:00

discounting a lot of risk because the odds that whatever

05:03

dot com doesn't make its four hundred million dollars in

05:07

projected app sales in two years well that's pretty good

05:11

could earn a lot less so you know you get

05:14

it You'll keep your shares of whatever dot com if

05:16

you believe they'll really hit the one hundred million in

05:19

earnings on four hundred million of revenues two years from

05:22

now and you'll dump the shares if you don't Well

05:25

what about pepsi Well that's company that financially sounds a

05:27

lot more like caterpillar than whatever dot com the risk

05:31

of people still drinking highly addictive caffeinated fizzy water and

05:35

salted potatoes in five years left pepsi sells a lot

05:38

of data chips Yeah really good odds Pepsi grows a

05:41

bit faster than caterpillar it has a bit higher margins

05:44

and it acquires competitors all the time dipping its toes

05:48

even outside the food and snacks arena So it has

05:50

a really big playing field that it plays on by

05:53

a lot of things and there's that global warming thing

05:56

People drink more when it's hot right So pepsi learn

05:59

about two bucks a share this year and it trades

06:02

that twenty times earnings or forty dollars Well because pepsi

06:05

has long term distribution contract with grocery stores and vending

06:09

machines and theme parks and other weird places it sells

06:12

its wears well pepsi has a pretty highly predictable earning

06:16

stream So when peopie tells the street that it'll learned

06:20

to twenty next year in two forty the following year

06:23

what likelihood Very high that it hits those numbers are

06:26

maybe does little better because it has a history of

06:28

under promising and over delivering and on its two bucks

06:31

forty and earnings at forty dollars pep trades at a

06:34

bit of a premium to the stock market overall that

06:37

to forty and earnings on a forty dollars a share

06:39

price today means that peopie trades at sixteen point six

06:43

times two years out Earnings well the overall stock market

06:47

trades at sixteen times this year's earnings because well earnings

06:50

are growing It trades it about fifteen times earnings two

06:53

years out Why all of these crazy comparisons That air

06:57

probably confusing you well because price to earnings ratios are

07:01

just one measure of the value of a company relative

07:05

to everything else The p e ratio is just one

07:09

metric investors used to measure the value of a company

07:13

and the basic foundation of the idea is simple If

07:16

you invest a dollar in a company today you want

07:19

to be paid back either by getting cash distributions coming

07:23

to you That overtime are much greater than that dollar

07:26

you put in like big dividends and so on Or

07:29

you want the asset itself to simply appreciate it A

07:32

healthy fast pace about eight dollars worth of stock Well

07:35

you want that stock to double every you know three

07:38

four five six years something like that Alright we'll announce

07:41

for your sister's rabbit collection Well that things should multiply

07:44

At a good rate too unless she decides to separate 00:07:47.975 --> [endTime] them