The price to earnings ratio, or P/E, is one of the most quoted numbers in investing. It tells you how much investors pay for each dollar of a company’s profit.
How to calculate it
Divide the share price by earnings per share. If a stock trades at $50 and the company earned $2 per share over the last year, the P/E is 25. Investors are paying $25 for each dollar of yearly profit.
How to read it
A higher P/E can mean investors expect strong growth. A lower P/E can mean slower growth expectations or concern. Neither is good or bad on its own. Compare with similar companies and with the company’s own history.
Forward vs trailing
Trailing P/E uses the last twelve months of earnings. Forward P/E uses analyst estimates for the next year. Estimates can be wrong, so keep that in mind.
Where P/E can mislead
- Companies with no profit have no P/E.
- One time gains or losses can distort earnings.
- Different industries have very different normal ranges.
Use it as a question starter
When a P/E looks very high or low, ask why. The answer, found in the filings and news, is where the real learning is.
The formula
The price to earnings ratio, or P/E, is the share price divided by earnings per share. A $50 stock that earned $2.50 per share over the last year has a P/E of 20. It tells you how much investors pay for each dollar of earnings.
How to read it
A high P/E can mean investors expect strong growth, or that the stock is expensive. A low P/E can mean it is cheap, or that the business is struggling. Compare P/E with similar companies and with the company’s own history.
Forward and trailing
Trailing P/E uses past earnings. Forward P/E uses estimates, which can be wrong.
Limits
P/E does not work for companies with no earnings. Use revenue, cash flow and the balance sheet as well. See value vs growth investing.
Frequently asked questions
What is a good P/E?
It depends on the industry and growth. Compare with peers.
More examples
Company A earns $4 per share and trades at $60, so its P/E is 15. Company B earns $1 per share and trades at $40, so its P/E is 40. B is more expensive per dollar of earnings. That may be fair if B is growing earnings much faster, or it may be too high. A is cheaper, but may be growing slowly. The ratio starts the question rather than answering it.
Related measures
The price to sales ratio compares price with revenue and is used for companies with no profit yet. The PEG ratio divides the P/E by the growth rate to adjust for growth. Price to book compares price with book value, used often for banks. Each has limits.
Comparing the right things
Compare P/E within an industry. Software companies often trade at higher P/Es than utilities or banks, because they are expected to grow faster. Also compare against the company’s own five-year range. A P/E well above its history needs a reason.
Traps
One-time gains or losses can distort earnings and the ratio. A very low P/E can be a value trap, where earnings are about to fall. Cyclical companies can look cheap at the peak of earnings and expensive at the bottom. Check the earnings report for the story behind the number.
How to use it
Use P/E as one filter among several. Then read the filings, check the balance sheet and decide your position size with the calculator.
Keep learning about p e ratio
Reading is a start, practice makes it stick. Run the numbers in our investor tools, test yourself in Stock Jeopardy, or follow the start here guides to see what to read next after p e ratio.
Further reading: Investor.gov from the U.S. SEC and the Canadian Securities Administrators investor education site offer free, independent guides for new investors.
The flip side: earnings yield
If you turn the P/E upside down, you get earnings divided by price. This is called the earnings yield. A stock with a P/E of 25 has an earnings yield of 1 divided by 25, which is 4%. A stock with a P/E of 10 has an earnings yield of 10%. Some people like this view because it looks like an interest rate. It shows how much profit the company earns for each dollar you pay. Remember that earnings are not paid to you in cash, and they can change.
Why growth changes the picture
Take two companies at the same $50 share price. Company A earns $2.50 per share and has a P/E of 20. Company B also trades at $50 but earns $1.00, so its P/E is 50. If Company B’s earnings grow 40% a year, then in two years it would earn about $1.96 per share. At the same $50 price, its P/E would fall to about 26. If growth stalls, the P/E stays high and the price may have to come down. A P/E only makes sense next to the growth story behind it.
Check which earnings number is used
Companies report basic and diluted earnings per share. Diluted EPS assumes that things like stock options become shares, so it is usually lower and more cautious. Some sites use adjusted earnings that leave out certain costs. Make sure you know which number a P/E uses before you compare two stocks. Different sites can show different P/E numbers for the same company for this reason.
Where to find the inputs
You can find earnings per share in the income statement of a company’s annual or quarterly report. In the United States, reports are on the SEC’s website at sec.gov. Then use the P/E ratio calculator to check the math yourself. For the bigger picture, read how to value a stock.
Common mistakes
- Comparing a bank’s P/E with a software company’s P/E.
- Using one year’s P/E to judge a company that has swings in profit.
- Treating a low P/E as proof the stock is a bargain.
- Forgetting that price per share says nothing about size. Check the market cap too.
What to do next
Pick three companies in one industry. For each, write down the price, the diluted EPS for the last twelve months, and the P/E. Then add the growth rate of earnings over the past three years. See which numbers line up and which do not. Ask why. That habit of asking why is worth more than any single ratio. The glossary can help with any unfamiliar term.
Education only, not investment advice.
