What the P/E ratio tells you
The price-to-earnings ratio compares a company’s share price with its profit per share. It answers a simple question: how many dollars are investors paying for one dollar of yearly earnings? A P/E of 25 means the market pays $25 for each $1 of earnings. It is the most quoted valuation measure in stock analysis, because it lets you compare companies of very different sizes.
The formulas
- P/E (trailing) = share price ÷ earnings per share of the last 12 months
- Forward P/E = share price ÷ expected EPS for the next 12 months
- PEG ratio = P/E ÷ expected yearly EPS growth in percent
- Earnings yield = EPS ÷ share price
Worked example
A stock trades at $150 with $6 of earnings per share over the last year, and analysts expect earnings to grow 12% a year.
- P/E = 150 ÷ 6 = 25.0.
- Next year’s EPS = 6 × 1.12 = 6.72, so the forward P/E = 150 ÷ 6.72 = 22.3.
- PEG = 25 ÷ 12 = 2.08.
- Earnings yield = 6 ÷ 150 = 4.00%.
Reading the P/E
| P/E | Usual reading |
|---|---|
| Negative or not meaningful | The company is losing money |
| Below 10 | Cheap, or the market expects earnings to fall |
| 10 to 25 | Around long-run market averages |
| Above 25 | The market prices in strong growth |
The S&P 500 has averaged a P/E of roughly 15 to 20 over the long run, with much higher readings in bubbles such as 1999. Always compare a company with its own history and with peers in the same industry: a software company and a bank are not valued the same way.
The PEG ratio
The PEG ratio, popularized by investor Peter Lynch, puts the P/E in context of growth. A PEG below 1 suggests a stock is cheap relative to its growth, around 1 is fair, and above 2 is expensive. Its weakness is that it depends on a growth forecast, which can be wrong.
Pitfalls
- One-off items: a big write-off or asset sale can make a single year’s EPS meaningless. Adjusted EPS removes them, but check what was adjusted.
- Cyclical companies: carmakers and miners look cheapest at the peak of their cycle, when earnings are highest.
- Interest rates: higher bond yields usually push P/E ratios down, which is why investors compare the earnings yield with Treasury yields.
This calculator gives estimates for education and planning. It is not investment, tax or legal advice; for decisions about your own situation, talk to a qualified financial professional.