P/E Ratio
The price-to-earnings ratio, or P/E ratio, is a stock's current share price divided by its earnings per share. It shows how many dollars investors are willing to pay for each dollar of a company's annual profit. A high P/E suggests the market expects strong future growth, while a low P/E may indicate a cheaper valuation or weaker prospects.
Worked example
A stock trades at $40 per share and the company earned $2.00 in earnings per share over the past year. P/E ratio = $40 ÷ $2.00 = 20. Investors are paying 20 times the company's annual earnings for the stock.
Why it matters
The P/E ratio is the most common shorthand for whether a stock looks cheap or expensive relative to its profits, and it makes companies of different sizes comparable. The main pitfall is using it in isolation: P/E is meaningless when earnings are negative, varies enormously across industries, and can look low simply because earnings are temporarily inflated. It is most informative when compared with peers and the company's own history.
Frequently asked questions
What is a good P/E ratio?
There is no single good level; it depends on the industry, growth rate and interest rates. A P/E below the company's peers or historical average can signal value, but a low P/E can also reflect genuine risks or shrinking earnings.
What is the difference between trailing and forward P/E?
Trailing P/E uses the past 12 months of actual earnings, while forward P/E uses analysts' forecast earnings for the next 12 months. Forward P/E reflects expectations but depends on the accuracy of those estimates.
Related terms: Earnings per Share (EPS), Intrinsic Value