PRICE TO EARNINGS RATIO (PE)

P/E ratio is calculated by dividing the current market price of the stock by its earning per share (EPS). 
P/E ratio = market price/EPS. It is a popular ratio that gives investors a better sense of the value of the company as it shows the sum of money one is willing to pay for each naira worth of a company's earnings.

Price to earnings gives investors idea if the stock has sufficient growth potential. Therefore, stocks with low PE are considered good bargains as their growth potential are still unknown to the market, at the same time, companies with higher PE ratios generally expect higher earnings growth in the future than companies with low PEs.

Assume there are two companies X and Y operating in the same sector. If the PE of company X is 30 and the PE of company Y is 20, then company Y is  considered to be a better buy, as market price has not gone up to reveal the earnings prospects of the company, while company X is considered to show higher growth prospects compared to company Y.

PE ratio is never the ultimate in selecting good stocks. Any news of a major order or acquisition by the company will certainly push up its PE. On the other hand, low PE may not indicate a good buy but could signify more serious issues facing the company. Therefore, it is very important to perform a thorough research into the background of the prospective company before investing.

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