The P/E ratio (Price-to-Earnings) is one of the most well-known and widely used tools in the stock market. At first glance, it seems simple: its value equals the current stock price divided by the company’s earnings per share.
What is the P/E ratio, and what does it show? The P/E ratio shows how much investors are willing to pay today for every dollar of future earnings a company is expected to generate. However, there are important nuances behind this apparent simplicity. The P/E ratio is not an absolute measure of whether a stock is cheap or expensive. It is rather a reflection of investor expectations.
To calculate the price-to-earnings ratio correctly and interpret it properly, investors need to understand the PE ratio formula and the market context. Let us look at how to calculate the price-earnings ratio and what to consider before making investment decisions.
The article covers the following subjects:
Major Takeaways
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The P/E ratio, or price-to-earnings ratio, shows how many years it would take an investor to earn back their investment at the current earnings level. A high pe ratio often reflects expectations of higher earnings growth, while a low pe ratio may signal an undervalued stock or business problems.
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Pe ratio formula: P/E = Market capitalization / Net annual income. For one share: P/E = Share price / Earnings per share (EPS). For example, if the share price is $1,000 and the company’s EPS is $50, the p e ratio equals 20.
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The trailing pe ratio is based on past earnings over the last 12 months. The forward pe ratio uses projected earnings for the next period and reflects future earnings guidance, while the trailing pe ratio reflects the company’s historical performance.
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An absolute pe ratio is the calculated value for one company. A relative pe ratio compares the value with the sector average, the overall market, or the company’s historical average. It is relative valuation that gives the p e ratio practical meaning.
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There is no single good pe ratio. A low pe ratio, for example, in the range of 5–15, may be typical for mature or undervalued stocks. A high pe ratio, for example, 25 and above, is often seen in growth stocks. It is important to compare companies from the same industry and consider earnings growth.
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Real-time PE ratios are published on financial websites, trading platforms, and in broker reports.
What Is the Price-to-Earnings (P/E) Ratio?
The P/E ratio, or price-to-earnings ratio, is one of the most important tools for investors. It helps assess whether it makes sense to invest in a particular company. This earnings p e ratio shows how much the market is willing to pay for each dollar of earnings. For example, if a company has a p e of 15, investors are ready to pay $15 for each dollar of earnings per share. If current earnings remain unchanged, the initial investment would theoretically pay off in 15 years.
However, the P/E ratio is not just a number. It reflects investor expectations about the company’s future earnings growth. Imagine two companies: one operates in high tech, the other in utilities. The tech company will most likely have a higher pe ratio because investors expect higher earnings growth. The utility company will probably have lower ratios, as its business is more stable but offers limited growth potential.
What is the P/E ratio for a stock? By itself, this number says little. To understand whether the stock price is high or low relative to its value, the pe ratio must be compared with relevant benchmarks. For example, you can compare it to the industry sector average for the company’s industry.
If the company’s P/E ratio is higher than the industry benchmark, the stock may be overvalued. If it is lower, it may be an undervalued stock with growth potential. It is also useful to compare the company’s pe ratio with its historical average. If the current price implies a much higher earnings multiple than before, it is important to understand why the market’s perception of the company has changed.
Comparing the pe ratio with similar companies and main competitors also helps evaluate the company’s earnings growth prospects. Overall, the P/E ratio is a useful tool, but investors should use it carefully as part of fundamental and investment analysis.
The PE Ratio Formula: How to Calculate Price Earnings Ratio
The P/E ratio formula is very simple and has two main versions.
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Based on the company as a whole:
P/E ratio = Market capitalization / Net income for the last 12 months. Market capitalization is the current market value of a company’s outstanding shares, calculated as the current stock price multiplied by the number of shares outstanding.
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Based on a single share, which is the more common method:
P/E ratio = Stock price / Earnings per share (EPS). Earnings per share (EPS) is the company’s net income divided by the number of shares outstanding.
How to calculate P/E? For example, Company B stock is trading at $2,000 per share. Its earnings per share over the past year were $100. Therefore, the P/E ratio = $2,000 / $100 = 20. An investor pays $20 for each dollar of annual earnings.
Note that the earnings per share used in the calculation must be consistent. If quarterly earnings are used, they should be annualized by multiplying by 4. In practice, it is easier to use data on annual earnings or earnings per share for the last 12 months (TTM), published by financial services.
Types of P/E Ratios: Trailing vs Forward
In fundamental analysis, two main types of the P/E ratio are used. They differ in the source of the earnings-per-share data: trailing P/E and forward P/E. The choice between them depends on the investment horizon.
Trailing P/E Ratio (TTM)
The trailing P/E ratio (TTM) is probably the most common and easiest to understand. It is based on already reported earnings. This P/E formula uses earnings per share for the completed year.
The main advantage of the trailing P/E ratio is that it relies on actual data. It is based on real numbers rather than assumptions, so it is harder to distort. This ratio is effective for evaluating companies with stable earnings and businesses that do not show strong seasonal or cyclical fluctuations.
However, there is also a drawback: the trailing P/E ratio reflects past earnings. If something significant has changed in the company, for example, a successful new product launch or the loss of a major client, last year’s earnings may no longer reflect the current situation. The company’s stock price already reflects expectations about future earnings, while the trailing P/E is based on past performance. As a result, investment analysis may be less accurate.
Despite its simplicity, this financial metric can reveal a lot about a company and its growth prospects. It is important to understand that the P/E ratio is only one of many financial metrics. It should be used alongside other stock valuation methods to provide a fuller picture of the company’s valuation.
Let us compare the trailing P/E ratios of Tesla Inc., a technology company, and Exxon Mobil Corp., an energy company. Tesla’s P/E ratio is 392.59, while Exxon Mobil’s is 23.31.
For Exxon Mobil, the trailing P/E may be more useful because its earnings are relatively predictable. For Tesla, where earnings may change significantly from year to year, the trailing P/E may be less informative.
Therefore, when using the trailing P/E ratio, it is important to consider the company’s business specifics and the current market conditions. Investors should not rely on a single ratio; they should conduct a broader investment analysis before making investment decisions.
Forward P/E Ratio
The forward P/E ratio is a dynamic, forward-looking indicator. To calculate it, analysts use expected earnings per share in the standard P/E formula instead of already reported earnings. They usually use projected earnings for the next 12 months. These are typically based on analysts’ consensus estimates for the company.
Why is the forward P/E ratio used? It better reflects current investor expectations. The company’s share price depends on how much earnings the company will generate in the future. If expected earnings are used in the calculation, the resulting P/E ratio reflects what the market currently believes.
This approach is especially useful for growth stocks, where future earnings growth may differ significantly from past earnings.
However, forecasts may be inaccurate. Analysts can be too optimistic or too pessimistic, especially during periods of economic uncertainty. If forward P/E is used, it should be remembered that it is based on assumptions that may not materialize. Investors should analyze the company’s past performance, the industry’s current conditions, and other factors that may affect future earnings growth before making investment decisions.
Absolute P/E vs Relative P/E Ratio
There are two main approaches to interpreting the P/E ratio: the Absolute P/E and the Relative P/E Ratio.
The absolute P/E is simply the number calculated using the formula. For example, stock A may have a P/E ratio of 10, while stock B has a P/E ratio of 25. It is impossible to say which is better without comparison. The P/E ratio may be low because the company has weak earnings growth prospects, and it may be high because investors expect higher earnings growth.
That is why it is important to use the Relative P/E Ratio in analysis. It allows investors to compare the company’s P/E with other benchmarks:
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With the sector average or industry benchmark. For example, for an IT company, a P/E of 40 may be normal, while for a metallurgical company, it may indicate that the stock is trading above its intrinsic value. It is important to consider the specifics of each industry. Each sector has its own earnings growth rates and profitability standards.
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With the company’s historical values. If the current price implies a P/E above or below the company’s usual level, it may signal a change in the company’s valuation.
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With direct competitors. If similar companies have P/E ratios that are twice as high, this may signal a low relative valuation. The stock may be trading at a low price. However, other factors may explain why the market’s perception differs.
Relative P/E helps assess whether the current market price is fair in the broader share market. By comparing the ratio with other financial metrics, investors can identify potential opportunities. However, the P/E ratio is only one valuation multiple. Investment decisions should be based on broader investment strategies, comparative analysis, and methods such as discounted cash flow. It is necessary to consider the company’s balance sheet, dividend yield, earnings yield, growth prospects, weighted average cost of capital, and the overall market situation.
What Is a Good P/E Ratio?
There is no simple answer to what makes a good or bad P/E ratio. Its interpretation depends on market sentiment and context.
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A low P/E, for example, 5–12, is typical for value stocks. These may be mature companies in stable industries such as energy or finance, with moderate earnings growth but regular dividends. A decline in the P/E ratio may also indicate temporary problems in the company or sectors that are not popular with investors. This is often an area of interest for value investors looking for undervalued growth stocks.
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A high P/E, for example, 25 and above, is typical for growth stocks such as technology start-ups or pharmaceutical companies. In this case, investors expect strong future earnings growth. A high price multiple reflects expectations of higher earnings growth. The risk is that if projected earnings do not materialize, the company’s stock price may fall sharply.
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A negative P/E appears when the company reports negative earnings. If a company is losing money, its negative eps results in a negative pe ratio. In this case, the ratio loses practical meaning, and investors must analyze the reasons for the losses.
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A positive P/E is normal, but it requires careful comparative analysis.
One important criterion is whether the P/E ratio corresponds to earnings growth. For this purpose, investors often use the peg ratio. A P/E of 20 may be appropriate for a fast-growing technology company and inappropriate for a large industrial company.
How to Find P/E Ratio Data for Stocks
Today, it is easy to find a stock’s P/E ratio, since all the information is available on financial services and broker websites.
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Financial portals and aggregators. That’s the most popular and cost-free method. Each publicly traded company has its current stock price, earnings per share, and calculated P/E ratio displayed on websites such as Finviz, Yahoo Finance, Morningstar, and Investing.com. In many cases, both versions are shown at once: trailing P/E and forward P/E.
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Investor terminals. Professional platforms such as Bloomberg Terminal or Reuters Eikon provide the most detailed and up-to-date financial metrics, including in-depth analysis of the P/E ratio. More accessible platforms for private investors include TradingView and MetaStock.
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Company and regulator reports. In quarterly and annual reports, investors can independently obtain data on the company’s net income and number of shares outstanding to calculate the P/E ratio using the formula.
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Broker apps and websites. Almost every broker displays key valuation multiples, including the P/E ratio, on the trading platform or in the client account under the instrument profile.
It is important to check which type of P/E ratio is being shown — trailing or forward — and what data it is based on.
Conclusion
The P/E ratio remains a fundamental analysis tool for stock screening and stock valuation. However, the key is to interpret this financial metric correctly. The P/E ratio gains real meaning only through comparative analysis, within the context of the industry, and in relation to the company’s earnings growth and performance.
When used alongside other financial metrics, the P/E ratio helps investors distinguish value stocks from overpriced companies and avoid decisions driven solely by market sentiment. It also allows investors to assess the company’s earnings, intrinsic value, and stock price relative to the broader market. Take advantage of the opportunities offered by LiteFinance to conduct effective market analysis and better evaluate future investments.
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