The weighted average of the price/earnings ratios of the stocks in a portfolio. The P/E ratio of a stock is calculated by dividing the current price of the stock by its trailing 12 months� earnings per share. In computing the average, Morningstar weights each portfolio holding by the percentage of equity assets it represents, so that larger positions have proportionately greater influence on the final P/E.
The P/E ratio relates the price of the stock to the per-share earnings of the company. A high P/E generally indicates that the market will pay more to obtain the company because it has confidence in the company�s ability to increase its earnings. Conversely, a low P/E indicates that the market has less confidence that the company�s earnings will increase, and therefore will not pay as much for its stock. In most cases high average P/E ratio indicates a manager has paid a premium for stocks that have a high potential for increased earnings. If the average P/E ratio is low, the manager may believe that the stocks have an overlooked or undervalued potential for appreciation.
Occasionally a stock considered a value stock will be selling at a high price/earnings. This can happen because the company has very low earnings, and is trading on the basis of book value or cash flow. Consequently, an out of favor stock may trade at less than its book value, yet have such low earnings that the price looks high in contrast to earnings.