Price to Earnings Ratio (P/E Ratio)

The Price to Earnings Ratio (P/E Ratio) is one of the most widely used metrics for determining stock valuation.

P/E Ratio Formula

Market Value per Share / Earnings per Share (EPS)

What is the P/E Ratio?

The P/E ratio valuation ratio measures its current share price relative to its per-share earnings. It indicates the dollar amount an investor can expect to invest in a company to receive one dollar of that company’s earnings.

What does a High P/E Ratio Mean?

A high P/E ratio suggests that investors are anticipating higher growth in the future. Investors are willing to pay a higher share price because of this expectation.

However, a high P/E ratio can also simply mean the stock is overvalued. Buying stocks with a very high P/E carries risk if the expected growth doesn't materialize.

What does a Low P/E Ratio Mean?

A low P/E ratio can indicate that the company is currently undervalued or that the company is doing exceptionally well relative to its past trends.

It can also mean that investors aren't confident in the company's future growth.

How to Use P/E Ratio

Tip: If the P/E ratio is lower than the industry average, it might be a good investment opportunity (value investing). Always compare the company's P/E against its industry peers.

Risks and When NOT to Use P/E Ratio

Warning: The P/E ratio is not useful for companies that are unprofitable (have negative earnings), as there is no denominator. Also, be cautious of P/E ratios manipulated by accounting practices that inflate earnings temporarily.

For unprofitable companies, consider using the Price to Sales Ratio instead.