1. Headline
  1. Headline
By John W. Schoen Senior Producer
msnbc.com

Q: The P/E earnings (ratio) has always confused me. Isn't the number an inverted fraction? If XYZ company's stocks sell for $1 and it earned $0.05 ,the price to earnings is 20 (1.00/.05) -- instead of a more friendly representation like 5 percent (.05/1.00 * 100). I would think it would be easier to understand if XYZ told its investors their stock value earned 5 percent. Please correct me if I'm wrong. —Jim C., Las Vegas

A: You could calculate it that way, but looking at the price paid for every penny of earnings is more like putting a “price tag” on each stock. To the extent that stocks trade on earnings, keeping the price in the numerator more accurately reflects prices paid. So the higher the P/E, the more you’re paying for the stock. (Inverting it would reverse this comparison.)

The percentage measure is usually reserved for ratios like Return on Equity or Return on Investment. That’s given as a percentage because it more like the return you get on a fixed income security or the dividend return on a stock.

About the only place you typically see a percentage given as a price is when you’re talking about bonds. When Treasury bonds are first issued, investors bid on them by naming the minimum interest rate they’ll accept before they’ll part with their money, lending it to the government. As those bonds are traded in the secondary market, the yield moves up and down depending on how much payback new investors want for their money.

© 2013 msnbc.com Reprints

Discuss:

Discussion comments

,

Most active discussions

  1. votes comments
  2. votes comments
  3. votes comments
  4. votes comments

More on TODAY.com

  1. Kevin Winter / Getty Images

    In defense of fanny packs, and Matthew McConaughey's style

    8/19/2014 9:49:55 PM +00:00 2014-08-19T21:49:55
  1. Trayvon Martin’s mom pens letter to Brown family

    The mother of Trayvon Martin offered her prayers to the family of Michael Brown, the unarmed black teenager who was killed by police in Ferguson, and said that parents of slain children “will no longer be ignored."

    8/19/2014 4:11:46 PM +00:00 2014-08-19T16:11:46
  1. Handout / Reuters file

    Amy Van Dyken-Rouen on the day that changed her life 'forever'

    8/19/2014 4:41:52 PM +00:00 2014-08-19T16:41:52