Valuation And Fundamental Analysis · Beginner · 7 minute read · No ads
P/E Ratio
Also called price earnings ratio, PE ratio, price earnings multiple
The P/E ratio divides a company’s share price by its earnings per share. A P/E of 20 means investors are paying $20 for each $1 of annual earnings. The number becomes useful only when the earnings period and comparison group are clear.
Key takeaways
- P/E compares share price with earnings per share and is usually expressed as a multiple such as 20 times.
- Trailing P/E uses reported earnings, while forward P/E uses estimated future earnings. Always label which version you are using.
- A low P/E is not automatically cheap and a high P/E is not automatically expensive. Growth, risk, margins, capital needs and earnings quality matter.
- P/E is not meaningful when earnings are zero or negative, and comparisons work best among businesses with similar economics.
What is the P/E ratio?
The price earnings ratio, usually written as P/E, compares a company’s share price with its earnings per share. It shows how many dollars investors are paying for each dollar of annual earnings, but it does not say whether the stock is cheap or expensive without context about growth, risk, earnings quality and comparable businesses.
How P/E Ratio works
| Step | What happens |
|---|---|
| 01 · Confirm the price date | Use a share price from a stated date so the numerator is clear. |
| 02 · Choose the earnings period | Decide whether the analysis uses trailing reported EPS or forward estimated EPS and label it. |
| 03 · Calculate the multiple | Divide the share price by EPS using consistent common equity data. |
| 04 · Add context before comparing | Check growth, risk, margins, earnings quality, cyclicality and the company’s own historical range. |
The formula
P/E ratio = Share price ÷ Earnings per share
Share price = current market price of one common share Earnings per share = net income attributable to common shareholders divided by the relevant weighted average share count Trailing P/E = price divided by reported earnings from the latest 12 months Forward P/E = price divided by estimated earnings for a future period
A worked P/E example with numbers
A company’s shares trade at $60 and its latest 12 month diluted earnings are $3 per share. The trailing P/E ratio is $60 divided by $3, or 20 times.
If analysts expect earnings of $4 per share next year, the forward P/E is 15 times. The forward figure is lower because it assumes earnings will grow. That growth is an estimate, not a fact.
If the share price remains $60 but trailing earnings fall to $2, the trailing P/E rises to 30 times. If earnings stay at $3 and the share price falls to $45, the P/E falls to 15 times. Both price and earnings can move the ratio.
Why it matters
P/E gives investors a quick way to compare what the market is paying for earnings. It is useful for screening and for comparing a company with its own history, but it is a starting point rather than a valuation conclusion.
Use the Stock Screener to compare P/E with growth, free cash flow and other measures. Then read the company’s filings to understand whether the earnings are repeatable.
Put P/E in context
Compare the multiple with growth, profitability and cash flow so one simple ratio does not drive the conclusion.
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Trailing P/E and forward P/E
Trailing P/E uses earnings already reported, commonly the latest 12 months. Forward P/E uses forecast earnings, often for the next fiscal year. Trailing data is observable but can be stale after a large change in the business. Forward data can be more relevant but depends on estimates that may be revised.
| Version | Denominator | Main benefit | Main limitation |
|---|---|---|---|
| Trailing P/E | Reported earnings from the latest 12 months | Based on published results | May not reflect current conditions |
| Forward P/E | Estimated earnings for a future period | Connects price with expected performance | Depends on forecasts that can be wrong |
What a high or low P/E can mean
A high P/E can reflect expectations for strong growth, durable margins, lower risk or unusually depressed current earnings. A low P/E can reflect slow growth, cyclical peak earnings, financial risk or a genuinely low price. The ratio alone cannot distinguish among these explanations.
Use comparable businesses carefully
P/E comparisons are strongest when companies have similar business models, growth, risk, accounting and capital needs. Comparing a mature utility with an early stage software company says little because the underlying economics are different. Compare the company with close peers and with its own history, then explain any gap.
Check the earnings behind the ratio
Read whether the data provider uses basic or diluted EPS, continuing operations or total net income, and reported or adjusted earnings. One time gains, write downs, tax items and share count changes can distort the denominator. A clean looking P/E can rest on weak earnings quality.
When P/E does not work
When EPS is zero or negative, the ratio is undefined or not economically meaningful. P/E can also be misleading for highly cyclical businesses near peak earnings. In those cases, examine normalized earnings, cash flow, book value or enterprise value measures that better match the business.
Comparison
| Aspect | Trailing P/E | Forward P/E |
|---|---|---|
| Earnings period | Latest reported 12 months | Estimated future period |
| Evidence | Published financial results | Analyst or company forecasts |
| Main use | Describe the price paid for recent earnings | Compare price with expected earnings |
| Main risk | Recent earnings may be unusually high or low | Forecasts may be optimistic or revised |
Check yourself
A stock trades at $60 and has trailing EPS of $3. What is its trailing P/E ratio?
$60 divided by $3 equals 20. Investors are paying $20 for each $1 of trailing annual earnings, before considering growth, risk or earnings quality.
Show the answer
20 times
Things people get wrong
Mistake 01 Calling every low P/E stock cheap
The market may be pricing falling earnings, high debt, weak growth or poor earnings quality.
Mistake 02 Mixing trailing and forward figures
A company’s trailing P/E cannot be compared cleanly with a peer’s forward P/E because the denominators cover different periods.
Mistake 03 Using P/E with negative earnings
A negative or zero denominator makes the multiple not meaningful. Showing a negative P/E can create a false impression of comparability.
Questions people ask about P/E Ratio
What does P/E stand for?
P/E stands for price earnings. It compares the market price of one common share with earnings per common share.
How do you calculate the P/E ratio?
Divide the current share price by earnings per share for a clearly identified period. A $60 price and $3 EPS produce a P/E of 20 times.
Is a high P/E ratio good or bad?
Neither by itself. It may reflect high expected growth or lower perceived risk, but it can also reflect an expensive price or temporarily weak earnings.
Is a low P/E ratio good or bad?
Neither by itself. A low ratio may indicate a low price, but it may also reflect slow growth, financial risk or peak cyclical earnings.
What is the difference between trailing and forward P/E?
Trailing P/E uses reported earnings from the latest 12 months. Forward P/E uses estimated earnings for a future period.
What happens when earnings are negative?
P/E is not meaningful when earnings are zero or negative. Other measures may be more useful, depending on the business.
Should P/E use basic or diluted EPS?
Diluted EPS is often more conservative because it includes the potential effect of convertible securities and options. Use the same basis when comparing companies.
Can P/E tell whether a stock is undervalued?
Not alone. It can identify a pricing difference, but growth, risk, earnings quality and business economics are needed to explain that difference.
The bottom line
The P/E ratio shows how much investors are paying for each dollar of earnings. It is simple to calculate but easy to misuse. Label the earnings period, check the quality and share count behind EPS, avoid the ratio when earnings are negative and compare businesses only after controlling for growth, risk and economics.
Sources
- Investor.gov, Price Earnings Ratio
- US Securities and Exchange Commission, Beginner’s Guide to Financial Statements
- US Securities and Exchange Commission, Earnings Per Share Glossary
- Aswath Damodaran, Financial Measures and Ratios
- Aswath Damodaran, P/E Ratios by Sector
How we produced the figuresThe worked example uses a $60 share price, $3 of latest 12 month diluted EPS and $4 of estimated forward EPS. The trailing P/E is 20 times and the forward P/E is 15 times. The example does not estimate fair value and does not assume that a lower multiple is automatically preferable.
Compare valuation measures in the stock screener
Filter US stocks by P/E, earnings growth, free cash flow and other measures. Use the results as a research shortlist, not a recommendation.
About this page. Written by Associate Professor Charles Lo, CPA, PhD and edited by Felix La Spina. Checked against reliable sources before publication. No ads and no paywall. Editorial standards · How we fact check · Corrections log · Report an error
Educational information only. Nothing on this page is personal financial, tax or legal advice. Investing involves risk, including the possible loss of principal.
