eli5: What does it mean when a CEO/CFO says “we are trading at 5x”?
In: Economics
Assuming the CEO/CFO is talking about their own stock, it means that if 100% of your company’s stock was purchased at its current price, it would cost 5X your company’s annual earnings.
That’s called a P/E (Price-to-Earnings ratio).
A really high P/E (over 30X) means that investors expect a company to be able to grow a lot in the next few months or years. They are willing to buy an overpriced stock now on the gamble that the company will achieve that growth.
Companies with a high P/E are under a lot of pressure to increase profits, and their stock will eventually tank if they are unable to do so.
A really low P/E generally means the stock is undervalued, so the expectation is that the stock price will likely go up, even with no business changes.
In some cases, a low P/E means the company is expected to shrink or fail in the future, but that’s less common.
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