Also known as: price to earnings ratio · price/earnings ratio · P/E ratio · price earnings ratio · P/E · PER · earnings multiple
Written by attorneys — see sources below.
A financial metric that expresses company value as earnings per share divided by the capitalization rate representative of the risks inherent in the company.
Pamela Phillips represents a small business owner seeking to sell her company. She normalizes the earnings over five years to arrive at a representative figure. She then divides those earnings by a capitalization rate reflecting the company's industry risks to determine the price-to-earnings ratio that supports the asking price.
Paul Peterson owns a commercial building and must value a tenancy at will for estate planning purposes. He determines the annual net earnings the property generates and divides by an appropriate capitalization rate. The resulting price-to-earnings ratio supplies the market value he reports to his appraiser.
The capitalization rate reflects the risks inherent in the particular company or asset. Selection involves judgment about industry conditions and the time period over which earnings are normalized.