The current price per share divided by last year’s earnings per share gives you __
A price to cash flow
B price-earnings ratio
C 1+
D market to book ratio
The correct answer and explanation is:
The correct answer is B: price-earnings ratio.
The price-earnings (P/E) ratio is a commonly used metric to assess the valuation of a company’s stock. It is calculated by dividing the current price per share by the earnings per share (EPS) from the most recent financial year. The P/E ratio reflects how much investors are willing to pay for each dollar of earnings and can provide insights into the market’s expectations for a company’s future growth.
A higher P/E ratio typically suggests that investors expect the company to experience strong future growth, while a lower P/E ratio might indicate that the company is undervalued or facing financial difficulties. The P/E ratio is often compared across companies within the same industry to determine relative valuations, though it can be influenced by various factors such as market conditions, interest rates, and investor sentiment.
In addition, the P/E ratio can be classified into two types: trailing P/E and forward P/E. The trailing P/E uses the most recent earnings to calculate the ratio, while the forward P/E uses projected future earnings. The forward P/E ratio can be more relevant for assessing companies with expected growth or those in cyclical industries.
Despite its widespread use, the P/E ratio has limitations. It does not account for differences in growth rates or the risk profiles of different companies. Furthermore, companies with little or no earnings will not have a meaningful P/E ratio, and other metrics, such as price-to-sales or price-to-book ratios, might be used to assess these companies.