What's the difference between absolute P/E ratio and relative P/E ratio?

What's the difference between absolute P/E ratio and relative P/E ratio?

--------------------------------------------------------------------------------

The simple answer to this question is that absolute P/E, which is the most quoted of the two ratios, is the price of a stock divided by the company's earnings per share (EPS). This measure indicates how much investors are willing to pay per dollar of earnings. The relative P/E ratio, on the other hand, is a measure that compares the current P/E ratio to the past P/E ratios of the company or to the current P/E ratio of a benchmark. Let's look at both absolute and relative P/E in more detail.

Absolute P/E

The nominator of this ratio is usually the current stock price, and the denominator may be

• the trailing EPS (from the trailing 12 months [TTM]),
• the estimated EPS for the next 12 months (forward P/E) or
• a mix of the trailing EPS of the last two quarters and
• the forward projected EPS for the next two quarters.

When distinguishing absolute P/E from relative P/E, it is important to remember that absolute P/E represents the P/E of the current time period.

For example, if the price of the stock today is $100, and the TTM earnings are $2 per share, the P/E is 50 ($100/$2).

Relative P/E

Relative P/E compares the current absolute P/E to

• a benchmark or
• a range of past P/Es over a relevant time period, such as the last 10 years.

Relative P/E shows what portion or percentage of the past P/Es the current P/E has reached.

• Relative P/E usually compares the current P/E value to the highest value of the range, but investors might also compare the current P/E to the bottom side of the range, measuring how close the current P/E is to the historic low.
• The relative P/E will have a value below 100% if the current P/E is lower than the past value (whether the past high or low).
• If the relative P/E measure is 100% or more, this tells investors that the current P/E has reached or surpassed the past value.

Suppose a company's P/Es over the last 10 years have ranged between 15 and 40.

• If the current P/E ratio is 25, the relative P/E comparing the current P/E to the highest value of this past range is 0.625 (25/40), and the current P/E relative to the low end of the range is 1.67 (25/15).
• These value tell investors that the company's P/E is currently 62.5% of the 10-year high, and 67% higher than the 10-year low.

If all is equal over the time period, the closer the P/E gets to the high side of the range and further away from the low side, the more caution an investor needs since this could mean the stock is overvalued.

• There is, however, a lot of discretion that goes into interpreting relative P/E.
• Fundamental shifts in the company such as an acquisition of a highly profitable entity can justifiably increase the P/E above the historic high.

As we mentioned above, relative P/E may also compare the current P/E to the average P/E of a benchmark such as the S&P 500.

• Continuing with the example above where we have a current P/E ratio of 25, suppose the P/E of the market is 20.
• The relative P/E of the company to the index is therefore 1.25 (25/20).
• This shows investors that the company has a higher P/E relative to the index, indicating that the company's earnings are more expensive than that of the index.
• A higher P/E, however, does not mean it is a bad investment. On the contrary, it may mean the company's earnings are growing faster than those represented by the index.
• If, however, there is a large discrepancy between the P/E of the company and the P/E of the index, investors may want to do additional research into the discrepancy.

Conclusion
Absolute P/E, compared to relative P/E, is the most-often used measure and is useful in investment decision making; however, it is often wise to expand the application of that measure with the relative P/E measure to gain further information.

http://www.investopedia.com/ask/answers/05/051005.asp