Price-earnings ratio (P/E) is the ratio of the current market price and the last published earnings per share. It is also called the multiplier because it represents the price that investors are willing to pay per unit of earnings.
The value of P/E itself has a little importance. For analysts is useful when comparing companies in the same industry.
The intrinsic value of companies can be determined by multiplying P/E ratios with EPS. On this basis, the expected P/E can be calculated as:
E (P/E) = (present value of shares) / EPS
Current P/E is calculated based on the current market price and the last published earnings per share:
Current P/E = (current market price of shares) / (current profit per share)
Based on the current P/E and the expected P/E ratios, investing strategy can be created:
If the current P/E is higher than expected, shares are overvalued and should be sold.
If the current P/E is less than expected, shares are undervalued and should be purchased.
If the current and expected P/E are almost the same, the share has a fair price and it is not expect to have some significant changes.