About P/E Ratio
What is P/E Ratio?
The Price-to-Earnings (P/E) ratio is a valuation metric that compares a company's stock price to its earnings per share (EPS). It shows how much investors are willing to pay for each dollar of earnings.
Formula
P/E Ratio = Stock Price ÷ Earnings Per Share (EPS)
Types of P/E Ratios
- Trailing P/E: Uses past 12 months earnings (most common)
- Forward P/E: Uses projected future earnings
- Shiller P/E (CAPE): Uses 10-year average inflation-adjusted earnings
Interpretation Guidelines
- Low P/E (< 15): Stock may be undervalued, value investment opportunity, or company has limited growth
- Moderate P/E (15-25): Stock is fairly valued, typical for mature companies
- High P/E (> 25): Stock may be overvalued, or investors expect high future growth
- Negative P/E: Company is losing money (negative earnings)
Industry Benchmarks
- Technology: 20-40 (high growth expectations)
- Financial Services: 10-15 (mature, stable)
- Utilities: 12-18 (stable, dividend-focused)
- Consumer Goods: 15-25 (moderate growth)
- Healthcare: 15-30 (varies by subsector)
Example Calculation
Company: ABC Corp
Stock Price: $150
EPS: $7.50
P/E Ratio: $150 ÷ $7.50 = 20
Interpretation: Investors are paying $20 for every $1 of earnings
Use Cases
- Compare companies within the same industry
- Identify potentially undervalued or overvalued stocks
- Assess market sentiment about growth prospects
- Screen stocks for value investing
- Evaluate if a stock price is justified by earnings
Limitations
- Not useful for companies with negative earnings
- Varies significantly across industries
- Can be manipulated through accounting practices
- Doesn't account for debt levels or growth rates
- Should be used with other valuation metrics (P/B, P/S, DCF)
Tips for Investors
- Always compare P/E ratios within the same industry
- Consider the PEG ratio (P/E divided by growth rate) for growth stocks
- Look at historical P/E trends for the company
- Compare to market average (S&P 500 average: ~15-20)
- Use P/E ratio alongside other fundamental analysis tools