What does it measure?
The P/E ratio tells you how many pounds you pay for the share for every pound of yearly profit the company earns per share. The formula: share price ÷ earnings per share. In simple terms, if the share count is constant and there are no non-controlling interests, EPS = net profit ÷ number of shares. The general formula uses the profit attributable to ordinary shareholders ÷ the weighted average number of shares.
A worked example
An invented company made EGP 60 million in a year, has 30 million shares, and trades at EGP 18. Step by step:
A P/E of 9 means the market is paying 9 times last year's profit. On its own that does not say the stock is cheap or expensive. You need to compare it with similar companies, with the company's own history, and with its growth prospects.
Three cases where it misleads
- A one-off gainIf the company sold land or another asset once, profit jumps for that year only and the P/E looks low. That profit will probably not repeat.
- A loss or near-zero profitIf the company lost money, P/E is negative and meaningless. If profit is tiny, P/E looks huge. On FoudaLens, a zero or negative P/E shows as "Loss" instead.
- Cyclical profitsSome industries earn in cycles. At the top of the cycle profit is high and P/E looks low, which may be exactly when profit is above normal.
See P/E on a real stock
Open any stock page and read the P/E and EPS together. Then ask: is this profit recurring, or is something one-off inside it?
Check yourself
1. Price EGP 25, EPS 2.50. What is the P/E?
2. A company has a low P/E because it sold a factory this year. What do you do?
Summary
- P/E = share price ÷ earnings per share.
- On its own it says neither cheap nor expensive; compare it with similar companies and with the company's history.
- It misleads with one-off gains, losses and cyclical profits.