Price–earnings ratio

This formula often gives the same answer as ⁠market price/ earnings per share⁠, (if new capital has been issued it gives the wrong answer), as market capitalization = (market price) × (current number of shares), whereas earnings per share = ⁠net income/ average number of shares⁠.

)[dubious – discuss] The price/earnings ratio (PER) is the most widely used method for determining whether shares are "correctly" valued in relation to one another.

For example, when U.S. treasury bonds yield high returns, investors pay less for a given earnings per share and P/E's fall.

[citation needed] Jeremy Siegel has suggested that the average P/E ratio of about 15 [7] (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 the lower capital gains tax rates and transaction costs, P/E ratio in "low twenties" is sustainable, despite being higher than the historic average.

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.

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.

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 private equity, the extrapolation of past performance is driven by stale investments.

Robert Shiller 's plot of the S&P composite real price–earnings ratio and interest rates (1871–2012), from Irrational Exuberance , 2d ed. [ 1 ] In the preface to this edition, Shiller warns that "the stock market has not come down to historical levels: the price–earnings ratio as I define it in this book is still, at this writing [2005], in the mid-20s, far higher than the historical average. ... People still place too much confidence in the markets and have too strong a belief that paying attention to the gyrations in their investments will someday make them rich, and so they do not make conservative preparations for possible bad outcomes."
S&P 500 Shiller P/E ratio compared to trailing 12 months P/E ratio
Price–earnings ratios as a predictor of twenty-year returns based upon the plot by Robert Shiller (Figure 10.1, [ 1 ] source ). The horizontal axis shows the real price–earnings ratio of the S&P Composite Stock Price Index as computed in Irrational Exuberance (inflation adjusted price divided by the prior ten-year mean of inflation-adjusted earnings). The vertical axis shows the geometric average real annual return on investing in the S&P Composite Stock Price Index, reinvesting dividends, and selling twenty years later. Data from different twenty-year periods is color-coded as shown in the key. See also ten-year returns . Shiller stated in 2005 that this plot "confirms that long-term investors—investors who commit their money to an investment for ten full years—did do well when prices were low relative to earnings at the beginning of the ten years. Long-term investors would be well advised, individually, to lower their exposure to the stock market when it is high, as it has been recently, and get into the market when it is low." [ 1 ]