How to Calculate a P/E Ratio

Video Transcript

"OK so how do we calculate a P/E ratio? The price to earnings ratio. It's very simple, you take the price of the stock and you divide that by the earnings. For example if a stock costs 20 dollars and it's making 2 dollars per share on every share that it makes, that's actually a P/E of 10. So you can see how that would change if it was only making 1 dollar per share your P/E would go from 10 to 20 because 20 divided by 1 dollar earnings would give you your 20 P/E. When you're looking at a price to earnings ratio, you want to look for a lower number than a higher number. Very high number over 20 for example means that the company's got a very expensive stock, it's not making a lot of earnings per share. If you find one say our first example that was a 20 dollar stock and it's making 2 dollars for every 20 dollars that you spend to buy a piece of that company, it's making 2 dollars in profit. That's those are great earnings and that was a P/E of 10. So you want to look for a P/E generally around 15 is about ideal. If you get higher than that, then just look at the stock. It might be overpriced, it might actually be something that's going to come down in value in the future. But you also look historically. Some companies are more profitable than others and that's really going to depend on the industry and the environment in the market at that point in time."