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31-398: The price–earnings ratio , also known as P/E ratio , P/E , or PER , is the ratio of a company's share (stock) price to the company's earnings per share . The ratio is used for valuing companies and to find out whether they are overvalued or undervalued. As an example, if share A is trading at $ 24 and the earnings per share for the most recent 12-month period is $ 3 , then share A has

62-446: A "primary" P/E can be used instead, based on the earnings projections made for the next years to which a discount calculation is applied. As the ratio of a stock (share price) to a flow (earnings per share), the P/E ratio has the units of time. It can be interpreted as the amount of time over which the company would need to sustain its current earnings in order to make enough money to pay back

93-401: A P/E ratio of ⁠ $ 24 / $ 3/year ⁠ = 8 years. Put another way, the purchaser of the share is investing $ 8 years to recoup the share price. Companies with losses (negative earnings) or no profit have an undefined P/E ratio (usually shown as "not applicable" or " N/A "); sometimes, however, a negative P/E ratio may be shown. There is a general consensus among most investors that

124-456: A P/E ratio of around 20 is 'fairly valued'. There are multiple versions of the P/E ratio, depending on whether earnings are projected or realized, and the type of earnings. Some people mistakenly use the formula ⁠ market capitalization / net income ⁠ to calculate the P/E ratio. This formula often gives the same answer as ⁠ market price / earnings per share ⁠ , but if new capital has been issued it gives

155-531: A given earnings per share and P/E's fall. The average U.S. equity P/E ratio from 1900 to 2005 is 14 (or 16, depending on whether the geometric mean or the arithmetic mean , respectively, is used to average). Jeremy Siegel has suggested that the average P/E ratio of about 15 (or earnings yield of about 6.6%) arises due to the long-term returns for stocks of about 6.8%. In Stocks for the Long Run , (2002 edition) he had argued that with favorable developments like

186-552: A long-term view of the financial markets, starting in 1802, mainly in the United States (but with some comparisons to other financial markets as well). Siegel takes an empirical perspective in answering investing questions. Even though the book has been termed "the buy and hold Bible", the author occasionally concedes that there are market inefficiencies that can be exploited. Siegel argues that stocks have returned an average of 6.5 percent to 7 percent per year after inflation over

217-481: A period of several years, one could formulate something of a standardized P/E ratio, which could then be seen as a benchmark and used to indicate whether or not a stock is worth buying. In private equity , the extrapolation of past performance is driven by stale investments. State and local governments that are more fiscally stressed by higher unfunded pension liabilities assume higher portfolio returns through higher inflation assumptions, but this factor does not attenuate

248-442: A sufficiently long period of time, stocks are less risky than bonds, where risk is defined as the standard deviation of annual return. During 1802–2001, the worst 1-year returns for stocks and bonds were -38.6% and -21.9% respectively. However, for a holding period of 10-years, the worst performance for stocks and bonds were -4.1% and -5.4%; and for a holding period of 20 years, stocks have always been profitable. Figure 2.6 shows that

279-467: Is computed slightly differently. The Fed model of stock valuation was not applicable before 1966. Before 1982, the treasury yields were generally less than stock earnings yield. Why the long-term return is relatively constant , remains a mystery. The dividend yield is correlated with real GDP growth, as shown in Table 6.1. Explanation of abnormal behavior: In Chapter 2, he argues (Figure 2.1) that given

310-405: Is greater than the par value, as in a rights issue, the shares are said to be sold at a premium (variously called share premium , additional paid-in capital or paid-in capital in excess of par). This equation shows the constituents that make up a company's real share capital: This is differentiated from share capital in the accounting sense, as it presents nominal share capital and does not take

341-654: Is maintained, and that dividends are not paid when a company is not showing a profit above the level of historically recorded legal capital. Stocks for the Long Run Siegel is a professor of finance at the Wharton School of the University of Pennsylvania and a contributor to financial publications like The Wall Street Journal , Barron's , The New York Times , and the Financial Times . The book takes

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372-457: The Dot-com bubble P/E had risen to 32. The collapse in earnings caused P/E to rise to 46.50 in 2001. It has declined to a more sustainable region of 17. Its decline in recent years has been due to higher earnings growth . Due to the collapse in earnings and rapid stock market recovery following the 2020 Coronavirus Crash , the trailing P/E ratio reached 38.3 on October 12, 2020. This elevated level

403-503: The 2002 edition of the book . This table presents some of the main findings presented in Chapter 1 and some related text. Stocks on the long term have returned 6.8% per year after inflation , whereas gold has returned -0.4% (i.e. failed to keep up with inflation) and bonds have returned 1.7% . The equity risk premium (excess return of stocks over bonds) has ranged between 0 and 11%, it was 3% in 2001. Also see [1] where equity risk premium

434-455: The PER does not in itself indicate whether the share is a bargain. The PER depends on the market's perception of the risk and future growth in earnings. A company with a low PER indicates that the market perceives it as higher risk or lower growth or both as compared to a company with a higher PER. The PER of a listed company's share is the result of the collective perception of the market as to how risky

465-582: The average P/E ratio for the S&;P 500 index has ranged from 4.78 in Dec 1920 to 44.20 in Dec 1999. However, except for some brief periods, during 1920–1990 the market P/E ratio was mostly between 10 and 20. The average P/E of the market varies in relation with, among other factors, expected growth of earnings, expected stability of earnings, expected inflation, and yields of competing investments. For example, when U.S. treasury bonds yield high returns, investors pay less for

496-414: The bonds during 1797–1942. After 1982, the bonds have slightly outperformed the stocks. McQuarrie also noted Siegel relied heavily on earlier flawed interpretations of Frederick Macaulay 's seminal The Movements of Interest Rates (1938), thus Siegel "under-estimate[d] 19th century bond returns" by about 1.5%. The yield on 10 Year Treasurys bottomed in early 1940s and then peaked at 15.6% in late 1981, and

527-433: The company is and what its earnings growth prospects are in relation to that of other companies. Investors use the PER to compare their own perception of the risk and growth of a company against the market's collective perception of the risk and growth as reflected in the current PER. If investors believe that their perception is superior to that of the market, they can make the decision to buy or sell accordingly. Since 1900,

558-420: The current share price. While the P/E ratio can in principle be given in terms of any time unit, in practice it is essentially always implicitly reported in years, with the unit of "years" rarely indicated explicitly. (This is the convention followed in this article.) The price/earnings ratio (PER) is the most widely used method for determining whether shares are "correctly" valued in relation to one another. But

589-420: The extrapolative effects of past returns. When a company has no earnings or is posting losses, in both cases P/E will be expressed as "N/A." Though it is possible to calculate a negative P/E, this is not the common convention. Share capital A corporation 's share capital , commonly referred to as capital stock in the United States, is the portion of a corporation's equity that has been derived by

620-431: The following topics. According to Siegel's web site the next edition will include a chapter on globalization with the premise that the growth of emerging economies will soon out pace that of the developed nations. A discussion on fundamentally weighted indexes which have historically resulted in better returns and lower volatility may also be added. The data below is taken from Table 1.1, 1.2, Fig 1.5 and Fig 6.4 in

651-422: The future compared to companies with a lower price–earning ratio. A low price–earning ratio may indicate either that a company may currently be undervalued or that the company is doing exceptionally well relative to its past trends. The price-to-earnings ratio can also be seen as a means of standardizing the value of one dollar of earnings throughout the stock market. In theory, by taking the median of P/E ratios over

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682-407: The interim. Shiller also notes that the 20th century, on which many of Siegel's conclusions are based, was the most successful century for stocks in the short history of the United States and such performance may not be repeated in the future. In 2019, Edward F. McQuarrie has published results showing that while the stocks outperformed bonds during 1943–1982, the return from stocks was about equal to

713-400: The issue of shares in the corporation to a shareholder, usually for cash . Share capital may also denote the number and types of shares that compose a corporation's share structure. In accounting , the share capital of a corporation is the nominal value of issued shares (that is, the sum of their par values , sometimes indicated on share certificates). If the allocation price of shares

744-596: The last 200 years. He expects returns to be somewhat lower in the next couple of decades. In an article presented at the Equity Risk Premium forum of November 8, 2001, Siegel states: An analysis of the historical relationships among real stock returns, P/Es, earnings growth, and dividend yields and an awareness of the biases justify a future P/E of 20 to 25, an economic growth rate of 3 percent, expected real returns for equities of 4.5–5.5 percent, and an equity risk premium of 2 percent (200 bps). The book covers

775-452: The lower capital gains tax rates and transaction costs, P/E ratio in "low twenties" is sustainable, despite being higher than the historic average. Set out below are the recent year end values of the S&;P 500 index and the associated P/E as reported. For a list of recent contractions ( recessions ) and expansions see U.S. Business Cycle Expansions and Contractions . Note that at the height of

806-476: The market assigns to those earnings. In turn, the primary drivers for multiples such as the P/E ratio is through higher and more sustained earnings growth rates. Consequently, managers have strong incentives to boost earnings per share, even in the short term, and/or improve long-term growth rates. This can influence business decisions in several ways: In general, a high price–earning ratio indicates that investors are expecting higher growth of company's earnings in

837-685: The optimally lowest risk portfolio even for a one-year holding, will include some stocks. In Chapter 5, he shows that after-tax returns for bonds can be negative for a significant period of time. Some critics argue that the book uses a perspective that is too long to be applicable to today's long-term investors who, in many cases, are not investing for a 20–30 year period. Furthermore, critics argue that picking different start and end dates, or different starting valuations, can yield significantly different results. Over certain long term periods, assets such as bonds, commodities, real estate, foreign equities or gold significantly outperform US stocks, usually when

868-449: The premium value of shares into account, which instead is reported as additional paid-in capital. Legal capital is a concept used in European corporate and foundation law , United Kingdom company law , and various other corporate law jurisdictions to refer to the sum of assets contributed to a company by shareholders when they are issued shares. The law often requires that this capital

899-461: The starting valuation for stocks is significantly higher than the norm. Economist Robert Shiller of Yale University , wrote in his book Irrational Exuberance (Princeton, 2000) even a 20 or 30 year holding period is not necessarily as risk-free as Siegel implies. Purchasing stocks at a high valuation based on the CAPE ratio can yield poor returns over the long term, as well as significant drawdowns in

930-711: The wrong answer, as market capitalization = ( market price ) × ( current number of shares), whereas earnings per share = ⁠ net income / weighted average number of shares ⁠ . Variations on the standard trailing and forward P/E ratios are common. Generally, alternative P/E measures substitute different measures of earnings, such as rolling averages over longer periods of time (to attempt to "smooth" volatile or cyclical earnings, for example), or "corrected" earnings figures that exclude certain extraordinary events or one-off gains or losses. The definitions may not be standardized. For companies that are loss-making, or whose earnings are expected to change dramatically,

961-436: Was only attained twice in history, 2001-2002 and 2008-2009. The P/E ratio of a company is a major focus for many managers. They are usually paid in company stock or options on their company's stock (a form of payment that is supposed to align the interests of management with the interests of other stock holders). The stock price can increase in one of two ways: either through improved earnings or through an improved multiple that

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