Chartered Financial Analyst (CFA) Level 1 Practice Exam

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How is the Price to Earnings (P/E) ratio calculated?

Price per share / Earnings per share
Price per share / Cash flow per share
Price per share / Sales per share
Price per share / Book value per share

The correct answer is: Price per share / Earnings per share

The calculation of the Price to Earnings (P/E) ratio is done by dividing the price per share by the earnings per share. This metric is widely used in finance to evaluate a company's relative value and to compare its current share price to its earnings, which can indicate if the stock is overvalued or undervalued. The P/E ratio provides insight into how much investors are willing to pay for each dollar of earnings, allowing analysts and investors to assess the company's profitability relative to its share price. A higher P/E ratio may suggest that the market expects future growth and profitability, while a lower ratio might indicate the opposite or suggest that the stock may be undervalued relative to its earnings. The other options involve different financial metrics that do not relate to the standard calculation of the P/E ratio. Cash flow per share, sales per share, and book value per share are components relevant in other contexts, such as cash flow analysis, revenue multiples, and valuation against net assets, respectively, but they do not form part of the P/E ratio calculation.