Absolute P/E Ratio vs. Relative P/E Ratio: What’s the Difference?

Absolute P/E Ratio vs. Relative P/E Ratio: An Overview

The absolute and relative P/E ratios are metrics to determine if a company is over or undervalued. The simple answer to this question is that absolute P/E is the price of a stock divided by the company’s earnings per share (EPS). This is the more common measure, and it 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.

Key Takeaways

• The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings.
• Analysts may make a distinction between absolute P/E and relative P/E ratios in their analysis.
• Absolute P/E is the current price-to-earnings calculated as usual. Relative P/E compares that to some benchmark or a range of past P/Es, say over the past 10 years. 

Absolute P/E Ratio

The numerator 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 P/E 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 Ratio

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 is 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.

Important

When calculating a company’s earnings per share, it is important to use the diluted EPS, not the basic EPS.

Example of Absolute vs. Relative P/E Ratio

Suppose that a company’s shares are currently trading for $100, and the company reports $4 of earnings per share. The company’s absolute P/E ratio is 25, meaning that shareholders pay $25 for every $1 of earnings. This is the P/E ratio that is usually reported on stock screeners or company summaries.

But stock analysts may wish to examine how the company’s absolute P/E ratio has changed over time, or how it compares with the industry at large. Suppose that the company’s P/E ratio has ranged from 15 to 40 over the past ten years. If the current (absolute) 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 values tell investors that the company’s current P/E is 62.5% of the 10-year high, and 67% higher than the 10-year low.

Special Considerations

If all is equal over a given time period, a P/E ratio that is close to its historical high could be a sign that the stock is overvalued. However, there is a lot of discretion that goes into interpreting relative P/E. Fundamental shifts in the company, such as a major acquisition, can justifiably raise the P/E above the historic high.

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, suppose the average P/E ratio in the S&P 500 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 benchmmark, indicating that the company’s earnings are more expensive than those of other companies in the index.

A higher P/E, however, does not necessarily mean it is a bad investment. On the contrary, it may mean the company’s earnings are growing faster than those of other companies in the index. If there is a large discrepancy between the company’s P/E ratio and the P/E of the index, investors may want to do additional research into the discrepancy.

What Does the P/E Ratio Tell You?

The price-to-earnings ratio, or P/E, reflects the share price of a company relative to its actual profits, reflected in the company’s reported earnings. This tells investors whether the share price is relatively high or low, compared with other companies. A low P/E ratio indicates that a company could be a bargain investment, while a high P/E ratio suggests that the company may be overvalued. Different industries have different profit margins, so investors should be careful to compare P/E ratios across similar companies.

Is It Better for a P/E Ratio to Be Higher or Lower?

Value investors typically look for stocks with a low P/E ratio, as that indicates that the share price is low relative to the company’s earnings. That could be because that stock is undervalued in the market; however, it is also possible for a company to have a low share price due to news events or unfavorable market conditions.

What Does a Negative P/E Ratio Mean?

A negative price-to-earnings (P/E) ratio means that the stock has reported negative earnings—in other words, it is losing money. Although that’s generally a bad sign, it’s not uncommon for otherwise-successful companies to lose money if they go through a temporary rough patch, or if they focus on reinvesting their revenue for future growth.

The Bottom Line

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.