Price-to-Earnings Ratio (P/E)

FundamentalStock Market1 min read

Quick Definition

A valuation metric comparing a company's stock price to its earnings per share, indicating how much investors pay per dollar of earnings.

What Is Price-to-Earnings Ratio (P/E)?

The Price-to-Earnings (P/E) ratio is one of the most widely used stock valuation metrics. It tells you how much investors are willing to pay for each dollar of a company's earnings.

Formula: P/E Ratio = Stock Price / Earnings Per Share (EPS)

Types of P/E:

  • Trailing P/E: Based on last 12 months' actual earnings
  • Forward P/E: Based on projected future earnings
  • Shiller P/E (CAPE): Uses 10-year average inflation-adjusted earnings

Interpretation:

  • High P/E (25+): Investors expect high growth, or stock is overvalued
  • Low P/E (<15): Stock may be undervalued, or company has problems
  • Market Average: S&P 500 historical average is ~15-17

Limitations:

  • Doesn't work for unprofitable companies
  • Earnings can be manipulated
  • Ignores growth rate (use PEG ratio instead)
  • Varies significantly by industry

Best Practices:

  • Compare P/E within same industry
  • Consider growth rate alongside P/E
  • Look at historical P/E trends for the company

Formula

Formula

P/E = Stock Price / EPS

Price-to-Earnings Ratio (P/E) Example

  • 1Stock at $100 with $5 EPS = P/E of 20
  • 2Apple P/E of 28 vs S&P 500 average of 22

Related Terms

Earnings Per Share (EPS)

A company's profit divided by its outstanding shares, showing how much money a company makes for each share of stock.

PEG Ratio

Price/Earnings-to-Growth ratio adjusts P/E by earnings growth rate, helping identify undervalued growth stocks.

Price-to-Book Ratio (P/B)

A ratio comparing a stock's market value to its book value, used to identify potentially undervalued companies.

Stock

A security representing ownership in a corporation, entitling the holder to a share of profits and voting rights.

Initial Public Offering (IPO)

The first sale of a company's stock to the public, transitioning it from private to publicly traded.

NASDAQ

The National Association of Securities Dealers Automated Quotations — the second-largest stock exchange globally, known for its concentration of technology and growth companies.

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