What Is the P/E Ratio? How to Tell If a Stock Is Expensive

The price-to-earnings ratio, or P/E, is a company's share price divided by its earnings per share. It tells you how many dollars investors are paying for each dollar of the company's annual profit, which makes it the most common quick gauge of how expensive a stock is. A P/E of 20 means the market is paying 20 dollars for every 1 dollar the company earns in a year.

New investors often reach for the share price to judge whether a stock is expensive, but as market cap shows, the price alone means little. The P/E ratio puts the price in the context of what the company actually earns. This page explains how the P/E is calculated, what a high or low number means, why you compare it within a sector, and where it falls short. It is descriptive throughout.

How the P/E is calculated

The formula is:

P/E = share price divided by earnings per share

Earnings per share, or EPS, is the company's annual profit divided by its number of shares. So if a stock trades at 100 dollars and earned 5 dollars per share over the last year, its P/E is 20. You can also read the P/E as the number of years of current earnings it would take to add up to the price, holding earnings flat.

What a high or low P/E means

A high P/E means investors are paying a lot for each dollar of current earnings. That usually reflects an expectation of strong future growth: the market is pricing in profits the company does not yet make. It can also simply mean the stock is expensive.

A low P/E means investors are paying little per dollar of earnings. That can mark a company the market has overlooked, or one the market expects to shrink or struggle. A low number is not automatically a bargain and a high one is not automatically overpriced; the ratio raises the question rather than answering it.

Trailing versus forward P/E

There are two common versions. The trailing P/E uses the company's actual earnings over the past twelve months, so it is based on real, reported numbers. The forward P/E uses analysts' estimates of the next twelve months' earnings, so it reflects expectations but depends on forecasts that can be wrong. Trailing is factual and backward looking; forward is predictive and only as good as the estimate.

Why you compare within a sector

A P/E is most useful next to a relevant benchmark, because normal levels vary widely by industry. Fast-growing software companies often carry high P/Es, while banks and utilities usually trade at low ones, and neither is mispriced for its type. Comparing a software company's P/E to a utility's tells you little; comparing it to other software companies tells you more. The ratio is a relative tool.

Where the P/E falls short

The P/E has real limits. A company with no profit, or a loss, has no meaningful P/E at all, so the ratio simply does not apply to many young or turnaround companies. Earnings can also be distorted by one-time events, accounting choices, or a single unusual quarter, which can make a P/E look artificially high or low. It is a fast first read, not a full verdict.

The price in a P/E is the share price Kresmion shows on each company's research page, and the earnings come from the company's financial filings, which Kresmion lists there as well.

Key takeaways

Frequently asked questions

How is the P/E ratio calculated?

Divide the share price by earnings per share (the annual profit per share). A 100 dollar stock that earned 5 dollars per share last year has a P/E of 20, meaning investors pay 20 dollars for each dollar of annual earnings.

What is a good P/E ratio?

There is no single good number, because normal P/E levels differ by industry and by how fast a company is growing. The ratio is most useful compared with a company's own history and with its peers in the same sector, rather than against an absolute rule.

What is the difference between trailing and forward P/E?

Trailing P/E uses the past twelve months of actual reported earnings, so it is factual. Forward P/E uses analysts' estimates for the next twelve months, so it reflects expectations but relies on forecasts that may not hold. One looks back at real numbers; the other looks ahead at projected ones.

Why do some companies not have a P/E?

Because a P/E needs earnings, and a company with no profit or a net loss has no meaningful ratio to show. Many young growth companies and companies in a turnaround fall into this group, which is why the P/E does not apply everywhere.

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Source: the price-to-earnings ratio is a standard valuation measure (share price divided by earnings per share). The price is what Kresmion shows on each research page, and earnings come from the company's financial filings, which Kresmion also lists. This page is information, not investment advice. Kresmion Research.