P/E Ratio

Stock price divided by earnings per share; a measure of how richly a stock is valued.

The Price-to-Earnings (P/E) ratio is one of the most widely used valuation metrics in equity analysis. It measures the relationship between a company's current stock price and its earnings per share (EPS). Essentially, the P/E ratio tells investors how much they must pay for every $1 of the company's annual earnings. Investors use this metric to determine if a stock is overvalued, undervalued, or fairly priced relative to its peers and its historical average. To calculate the P/E ratio, you divide the current market price of a single share by the company's earnings per share over a specific period. This period can look backward using historical data (Trailing P/E) or look forward using consensus analyst estimates for the next year (Forward P/E). While Trailing P/E relies on concrete, reported financial results, Forward P/E is highly dependent on the accuracy of future earnings forecasts. A high P/E ratio generally indicates that investors expect strong future earnings growth and are willing to pay a premium today. However, an exceptionally high P/E can also mean a stock is overvalued or that its earnings have temporarily plummeted. Conversely, a low P/E ratio can signal an undervalued bargain or a company in permanent decline (a "value trap"). To avoid pitfalls, investors should compare P/E ratios within the same industry, as typical ratios vary wildly between sectors like technology and utilities.

Company A trades at a market price of $90.00 per share. Over the last 12 months, the company reported a net income of $10 million and has 2 million outstanding shares, resulting in an earnings per share (EPS) of $5.00 ($10,000,000 / 2,000,000). The P/E ratio is calculated as $90.00 / $5.00 = 18x. This means investors are paying $18 for every $1 of Company A's earnings.