The price to earnings ratio, or P/E, tells you how much investors are paying for each unit of a company’s yearly profit. It is the most quoted valuation number there is, and one of the most misread.
In short
- P/E is the share price divided by earnings per share.
- A P/E of 20 means paying 20 for each 1 of yearly profit.
- Compare a company with its own history and direct competitors, not the whole market.
- A low P/E can signal trouble; a high one can be justified by fast growth.
How to calculate it
Divide the share price by the earnings per share over the last twelve months. A share priced at 50, with earnings of 2.50 per share, has a P/E of 20.
Another way to read it: if profits never changed, it would take twenty years of earnings to add up to the price you paid.
Comparing fairly
Different industries carry very different ratios. Fast growing software companies often trade at high multiples; banks and utilities usually trade at lower ones. Comparing a bank with a software company tells you nothing. Compare a company with its own past and with the businesses it actually competes against.
| What you see | A possible reason | What to check |
|---|---|---|
| P/E far below peers | Investors expect profits to fall | Is something wrong with the business? |
| P/E far above peers | Investors expect fast growth | Is the growth real and likely to last? |
| P/E jumps suddenly | Profit fell, price did not | Was it a one off or a trend? |
| P/E is negative or missing | The company made a loss | Use other measures, like revenue growth |
Four ways it misleads
- One off events, like selling a building, can inflate profit for a year and make the P/E look low.
- Cyclical companies, such as miners or carmakers, often look cheapest at the top of their cycle, when profits peak.
- It ignores debt. Two companies with the same P/E can carry very different risk.
- It looks backwards. Last year’s profit says little about a company whose next year will be very different.
A low P/E is a question, not a bargain.
Forward P/E
A forward P/E uses expected profit for the next year instead of the last. It looks ahead, but it rests on forecasts, which are often wrong. Treat both versions as starting points for questions.
For the rest of the picture, revenue, cash and debt, see how to research a stock before you buy it.
Common questions
What is a good P/E ratio?
There is no single good number. It depends on the industry and how fast the company is growing. Compare it with the company’s history and its competitors.
Is a low P/E ratio good?
Not necessarily. It can mean a bargain, or that investors expect profits to fall. Find out which before buying.
What does a negative P/E mean?
The company made a loss over the period, so the ratio is not meaningful. Look at revenue growth and cash instead.
What is the difference between trailing and forward P/E?
Trailing P/E uses the last twelve months of actual profit. Forward P/E uses forecasts for the next year.