Price-Earnings Relative

DEFINITION of Price-Earnings Relative

Price-earnings relative refers to the price-earnings ratio of a stock divided by the price-earnings ratio of a broader market measure. The price-earnings ratio, often written as P/E, is equal to a stock's or broad's market price divided by a measure of the stock's or alternately market's earnings. There are numerous methods for measuring the earnings figure used in the denominator of the formula, however practitioners normally use a measure of forward earnings, meaning earnings forecasts, or trailing earnings, meaning genuine reported earnings, over a year period. The price-earnings relative measure is meant to give a determination of the relative over-or undervaluation of a company relative to its industry, financial sector, the broad market or some other broad peer group.

BREAKING DOWN Price-Earnings Relative

The price-earnings relative value is a method for deciding whether a price-earnings ratio is reasonable in relation to market conditions. A price-earnings relative value of less than 1 indicates that a stock has a lower P/E ratio than its broader peer group. A price-earnings relative value of 1 indicates that a stock has the same P/E ratio as its peer group. A price-earnings relative value of greater than 1 indicates that a stock has a higher P/E than its peer group.

Interpreting the Price-Earnings Relative Value

The P/E ratio is often referred to when determining whether a stock represents a buying opportunity or not. At a fundamental level, a P/E value lower than the peer group and a corresponding price-earnings relative value of less than 1 might be an indication that the stock is trading cheaply, representing a great time to buy. The rationale for this decision is that a lower P/E indicates that each dollar of earnings costs less for this stock than for the average stock in the peer group. The reverse is true if the P/E for the stock is greater than that of the peer group and the price-earnings relative value is greater then 1, which might be an indication that the stock's earnings are more expensive than the average stock in the peer group.

It is worth noticing, however, that the P/E ratio and price-earnings relative value are just a single piece of a large mosaic of data that ought to be used to form an opinion on a stock. A low price-earnings relative value might indicate that the company is in dire financial straits, and not necessarily a decent buy. Conversely, a high price-earnings relative value might indicate that the firm has much better growth prospects and might be worth a higher price. Price-earnings relative values are a starting point for fundamental evaluation.