Q. How could a company have a price-to-earnings (P/E) ratio of 77 and a projected P/E of 22? How is it expected to change so quickly?
A. Imagine the Three-Legged Chair Company (ticker: OOOPS). If its stock currently trades at $77 per share and has $1 per share in annual earnings, its P/E is 77 (the price of the stock divided by the earnings per share of the previous four quarters).
Let's say it's growing rapidly, though, and is expected to earn $3.50 per share next year. If so, the projected P/E for that year is 22 ($77 divided by $3.50 is 22).
With a firm that's growing briskly, if the earnings grow more quickly than the stock price, the P/E ratio for future years will decrease noticeably.
To see this phenomenon in action with an actual company, take a gander at some data for online marketplace eBay (Nasdaq: EBAY) below (as of March of this year):
- Stock price: $89
- Current year's estimated earnings per share (EPS): $1.33
- P/E ratio on current year EPS: 66.9
- Next fiscal year's estimated EPS: $1.87
- P/E ratio on next fiscal year's EPS: 47.6
Here's an article covering the basics of P/E ratios, and a two-part series explaining why investors shouldn't put too much stock in P/Es (part 1 and part 2).
Learn more about investing in companies in our Investing Basics area. Also, check out our Mutual Fund area, and zero in on our index fund information there. You can also learn all about brokerages and find one that's right for you in our Broker Center.
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This question and answer is adapted from The Motley Fool Money Guide: Answers to Your Questions About Saving, Spending and Investing. For answers to this and 499 other common money questions, check it out -- it's a handy resource.
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