From the course: Financial Accounting Part 2

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Price-earnings ratio

Price-earnings ratio

From the course: Financial Accounting Part 2

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Price-earnings ratio

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- Let's talk about a unique category of ratios. Ratios that involve comparing a financial statement number with a market value number. Now, there are several ratios in this category, but the most often referenced of these ratios, is the PE ratio, the price to earnings ratio. The PE ratio reflects the relationship between the amount of a company's net income this year, its earnings, and the price or the market value that people are willing to pay for that company. As you would think, if a company has higher growth prospects in the future, the price earnings ratio is going to be higher because of this reason. When you buy a company, are you buying the past or are you buying its future? You're buying the future, and if the future looks very large compared to the earnings right now, you're going to have to pay a premium to buy that company. So a higher price earnings ratio reflects market expectations that earnings or net…

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