Price-to-Earnings (P/E) Ratio

Introduction

The P/E ratio is the most famous valuation measure. It compares a stock's price to its earnings and tells you how much investors pay per dollar of profit. This lesson explains it.

What P/E Means

P/E = Share price ÷ Earnings per share (EPS).

P/E = Price / EPS

A P/E of 20 means investors pay $20 for every $1 of annual earnings.

The Two Flavors

• Trailing P/E — uses the last 12 months' actual earnings
• Forward P/E — uses expected future earnings

Reading High and Low

• High P/E — investors expect strong future growth (or the stock is overvalued)
• Low P/E — the stock may be cheap (or the market expects weak growth)

Context Is Everything

Compare P/E to:

• The company's own history
• Peer companies in the same industry
• The market/sector average
• Growth rate (a fast-grower can justify a higher P/E)

Why P/E Can Mislead

• Cyclical companies' P/E flips when earnings swing
• A one-off earnings spike can distort trailing P/E
• Companies with no earnings have no meaningful P/E

Real-World Example

Stock X trades at $100 with EPS of $5 → P/E 20. Its growth rate is 25%/yr, while peers grow 8% at P/E 15. X's higher P/E may be justified by faster growth — or it may be stretched. Context decides.

Summary

• P/E = price ÷ earnings per share
• It shows how much investors pay per dollar of earnings
• High P/E = growth expectations or overvaluation; low = cheap or weak outlook
• Always compare to history, peers, industry, and growth
• Distorted by cyclical earnings and one-offs

Next Lesson

Other key ratios: P/B, EV/EBITDA, and dividend yield.