P/E ratio

The price-to-earnings ratio — P/E — is how much investors are currently paying for each dollar of a company's annual earnings. It is the most widely used valuation metric in equities.

Formula

p_e_ratio = current_share_price / earnings_per_share

A stock priced at $100 with $5 of earnings per share has a P/E of 20. Investors are paying $20 for every $1 of current earnings.

Trailing vs forward P/E

• Trailing P/E uses earnings from the past 12 months. It is a fact, not a projection.
• Forward P/E uses analyst estimates of next year's earnings. It is a projection that may or may not materialize.

Most published P/E figures are trailing unless explicitly noted. Forward P/E is usually lower than trailing P/E for growing companies, since earnings are expected to rise.

Typical ranges

• 5 – 12 — value-oriented. Common in slower-growing sectors (banks, energy, utilities) or out-of-favor stocks.
• 15 – 20 — broadly market-typical. The long-run S&P 500 average is around 15 – 17.
• 25 – 40 — growth premium. Companies expected to grow earnings rapidly enough to justify a higher multiple.
• > 50 or N/A — speculative or unprofitable. A negative P/E shows up when earnings are negative, which makes the metric meaningless.

What it really tells you

P/E is a compressed statement of expected growth. A P/E of 30 only makes sense if you believe earnings will grow significantly. A P/E of 8 only makes sense if you believe earnings will not decline. The number itself is neutral — what matters is whether the implied expectation is realistic.

Limitations

• Earnings are accounting numbers. They can be managed, restated, and inflated by one-time gains. Cash flow is harder to manipulate.
• No use across sectors. Comparing the P/E of a software company to a utility tells you nothing useful. P/E is a same-sector comparison metric.
• Cyclical earnings distort it. A cyclical company at the top of its cycle has high earnings and a low P/E — exactly when it is most expensive in real terms.
• Says nothing about quality. Two companies with identical P/Es can have very different balance sheets, growth profiles, and competitive positions.