What is the p/e ratio?
The price to earnings ratio is a measure of the company's current share price compared to the annual net earnings per share.  The other way to think about this is the number of years a company would take to pay back the share price if the earnings stay constant.  This ignores factors like inflation and can be used as an indicator of risk.  During the internet bubble many companies had P/E above 24 and no possible means of earning back the share prices that were inflated largely due to speculation. Most tools like Google Finance will list the P/E for a particular quote. The PE ratio stands for the Price-Earnings ratio. The price-earnings ratio is a straightforward formula: Share Price divided by earnings per share. Earnings per share is calculated by dividing the pre-tax profit for the company by the number of shares in issue. The PE ratio is seen by some as a measure of future growth of a company. As a general rule, the higher the PE, the faster the market believes a company will grow. This question is answered on our DividendMax website: http://www.dividendmax.co.uk/help/investor-glossary/what-is-the-pe-ratio Cheers PE ratio is the current share price divided by the prior 4 quarters earnings per share. Any stock quote site will report it. You can also compute it yourself. All you need is an income statement and a current stock quote.
"When presenting negative P/E values, most brokers and equity analysts show them as ""n.m."", which stands for not meaningful. I have never seen a P/E ratio of 0." Its Price/Earnings, or P/E, is at (roughly) 96 That means that for EVERY $1 that Amazon makes in profit, people are willing to pay $96 for it. This also means that for every $1 I invest in Amazon, I'll have to wait 96 years until I've collected on that - and that's assuming that 100% of their profit goes out through dividends, something that Amazon doesn't give out. This is either because the stock price is really high, or because its earnings is LOW.  Is this kind of ridiculous P/E common among the US stock (I'm not from the US)? Is there something going on in Amazon? Am I missing something (I'm a little new myself)?  I'm looking at [this graph](http://i.imgur.com/4YpDH.png). Return on Equity (aka RoE) has been going down. This is either because it has added more shareholders equity (equity issuance?), OR it's because net income has been falling. When you compare this to the rising P/E this recent year, something tells me that something is screwed up. People have been valuing Amazon *more and more*, while Amazon has been providing *less and less* to its shareholders!  [Here's more statistics](http://i.imgur.com/kJjPW.png) showing profit margin going down the last year, while the valuation went up (though it has been falling as it maxed at P/E 113).  So, either I've missed something (some awesome news or whatever), or I'm uneducated, or this stock has been overvalued. I'm assuming that it probably was a mix of the first and the last, and that this is just a correction. Correct *me* if I'm wrong. "Right, but there were tangible reasons that made sense. That was fueled by a cycle of predatory loans and consumers being dumb enough to think that just because they got approved for a $500K house with a 500 credit score meant they should definitely take out massive loans and buy it. This was piled on by the derivative market, specifically credit default swaps, which certain people recognized as creating a liquidity issue. They didn't know *when* the crash was going to occur. They just knew that the asset bubble fueled by massive debt, with this debt being falsely rated as AAA when most of it was Junk, left banks in a position of complete insolvency when the mortgage defaults reached a certain point. When people realized the extent of the debt, (e.g. knowing with common sense that people with a 550 credit score shouldn't have 7 properties and be allowed to be that over-leveraged, let alone be rated AAA) and the amount of derivatives that would have to be paid out on top of having no cash flow due to mortgage defaults, they recognized that a bubble bursting would wreak havoc on the economy.       That had a lot of moving parts. Simply saying ""DAE OVERVALUED RECORD HIGHS CRASH COMING SOON!??!?!?!??!!??!?!?!? WHEN!??!?! HOW!!?"" is fucking stupid. Nobody knows. What evidence did OP offer? Not that he wouldn't still get laughed out because this topic is fucking annoying with thousands of people crying ""overvalued"", but he didn't even mention P/E ratio or anything. He literally came in and basically said ""when is it all gonna fall apart?"". Nobody knows the answer." "Below I will try to explain two most common Binomial Option Pricing Models (BOPM) used. First of all, BOPM splits time to expiry into N equal sub-periods and assumes that in each period the underlying security price may rise or fall by a known proportion, so the value of an option in any sub-period is a function of its possible values in the following sub period. Therefore the current value of an option is found by working backwards from expiry date through sub-periods to current time. There is not enough information in the question from your textbook so we may assume that what you are asked to do is to find a value of a call option using just a Single Period BOPM. Here are two ways of doing this: First of all let's summarize your information: Current Share Price (Vs) = $70 Strike or exercise price (X) = $60 Risk-free rate (r) = 5.5% or 0.055 Time to maturity (t) = 12 months Downward movement in share price for the period (d) = $65 / $70 = 0.928571429 Upward movement in share price for the period (u) = 1/d = 1/0.928571429 = 1.076923077 ""u"" can be translated to $ multiplying by Vs => 1.076923077 * $70 = $75.38 which is the maximum probable share price in 12 months time. If you need more clarification here - the minimum and maximum future share prices are calculated from stocks past volatility which is a measure of risk. But because your textbook question does not seem to be asking this - you probably don't have to bother too much about it yet. Intrinsic Value: Just in case someone reading this is unclear - the Value of an option on maturity is the difference between the exercise (strike) price and the value of a share at the time of the option maturity. This is also called an intrinsic value.  Note that American Option can be exercised prior to it's maturity in this case the intrinsic value it simply the diference between strike price and the underlying share price at the time of an exercise. But the Value of an option at period 0 (also called option price) is a price you would normally pay in order to buy it. So, say, with a strike of $60 and Share Price of $70 the intrinsic value is $10, whereas if Share Price was $50 the intrinsic value would be $0. The option price or the value of a call option in both cases would be fixed.  So we also need to find intrinsic option values when price falls to the lowest probable and rises to the maximum probable (Vcd and Vcu respectively) (Vcd) = $65-$60 = $5 (remember if Strike was $70 then Vcd would be $0 because nobody would exercise an option that is out of the money) (Vcu) = $75.38-$60 = $15.38 1. Setting up a hedge ratio:  h = Vs*(u-d)/(Vcu-Vcd) h = 70*(1.076923077-0.928571429)/(15.38-5) = 1 That means we have to write (sell) 1 option for each share purchased in order to hedge the risks. You can make a simple calculation to check this, but I'm not going to go into too much detail here as the equestion is not about hedging. Because this position is risk-free in equilibrium it should pay a risk-free rate (5.5%). Then, the formula to price an option (Vc) using the hedging approach is: (Vs-hVc)(e^(rt))=(Vsu-hVcu) Where (Vc) is the value of the call option, (h) is the hedge ratio, (Vs) - Current Share Price, (Vsu) - highest probable share price, (r) - risk-free rate, (t) - time in years, (Vcu) - value of a call option on maturity at the highest probable share price. Therefore solving for (Vc): (70-1*Vc)(e^(0.055*(12/12))) = (75.38-1*15.38) => (70-Vc)*1.056540615 = 60 => 70-Vc = 60/1.056540615 => Vc = 70 - (60/1.056540615)  Which is similar to the formula given in your textbook, so I must assume that using 1+r would be simply a very close approximation of the formula above. Then it is easy to find that Vc = 13.2108911402 ~ $13.21 2. Risk-neutral valuation: Another way to calculate (Vc) is using a risk-neutral approach. We first introduce a variable (p) which is a risk-neutral probability of an increase in share price. p = (e^(r*t)-d)/(u-d) so in your case: p = (1.056540615-0.928571429)/(1.076923077-0.928571429) = 0.862607107 Therefore using (p) the (Vc) would be equal: Vc = [pVcu+(1-p)Vcd]/(e^(rt)) => Vc = [(0.862607107*15.38)+(0.137392893*5)]/1.056540615 => Vc = 13.2071229185 ~ $13.21 As you can see it is very close to the hedging approach. I hope this answers your questions. Also bear in mind that there is much more to the option pricing than this. The most important topics to cover are: Multi-period BOPM Accounting for Dividends Black-Scholes-Merton Option Pricing Model" "There are two common types of P/E ratio calculations: ""trailing"" and ""forward"" (and then there are various mixes of the two). Trailing P/E ratios are calculated as [current price] / [trailing 12-month EPS]. An alternative is the Forward P/E ratio, which is based on an estimate of earnings in the coming 12 months. The estimate used is usually called ""consensus"" and, to answer your question, is the average estimate of analysts who cover the stock. Any reputable organization will disclose how they calculate their financials. For example, Reuters uses a trailing ratio (indicated by ""TTM"") on their page for BHP. So, the first reason a PE ratio might not jump on an announcement is it might be forward looking and therefore not very sensitive to the realized earnings. The second reason is that if it is a trailing ratio, some of the annual EPS change is known prior to the annual announcement. For example, on 12/31 a company might report a large drop in annual earnings, but if the bulk of that loss was reported in a previous quarterly report, then the trailing EPS would account partially for it prior to the annual announcement.  In this case, I think the first reason is the culprit. The Reuters P/E of nearly 12 is a trailing ratio, so if you see 8 I'd think it must be based on a forward-looking estimate." generally Forward P/E is computed as current price / forward earnings.  The rationale behind this is that buying the stock costs you the current price, and it gives you a claim on the future earnings. This was such a wonderful and clear explanation. It has helped me to understand (at 28) a concept that I have always been a bit murky on. I would feel safe making the bet that you are a teacher of some sort. I would find it extremely interesting to hear you thoughts on why we don't use the gold standard anymore. Do you work in finance? NAV is  how much is the stuff of the company worth divided by the number of shares. This total is also called book value. The market cap is share price times number of shares. For Amazon  today people are willing to pay 290 a share for a company with a NAV of 22 a share. If of nav and price were equal the P/B (price to book ratio) would be 1, but for Amazon it is 13.  Why? Because investors believe Amazon is worth a lot more than a money losing company with a NAV of 22.