What is P/E Ratio?
Understand the price-to-earnings ratio and how to use it to evaluate if a stock is a good deal.
Quick Answer
The P/E ratio (Price-to-Earnings ratio) tells you how much investors are willing to pay for $1 of a company's earnings. A P/E of 20 means investors pay $20 for every $1 the company earns annually. Lower P/E ratios may indicate undervalued stocks, while higher P/E ratios may suggest growth expectations or overvaluation.
The Simple Formula
P/E Ratio = Stock Price ÷ Earnings Per Share (EPS)
Real Example: Apple Inc.
Stock price: $180
Earnings per share (EPS): $6.00
↓
P/E Ratio = 30
This means investors are paying $30 for every $1 of Apple's annual earnings.
What Different P/E Ratios Mean
Low P/E (Under 15)
Could indicate an undervalued stock, a value investment, or a company with limited growth prospects.
Example: AT&T (T) — P/E of 8
A mature telecom company with slow growth but stable earnings. Low P/E reflects limited growth expectations.
Average P/E (15-25)
Fairly valued stocks with moderate growth expectations. The S&P 500 historical average is around 15-16.
Example: Coca-Cola (KO) — P/E of 24
A stable blue-chip company with consistent earnings and moderate growth potential.
High P/E (25-50+)
Investors expect strong future growth. Could be justified or could indicate overvaluation.
Example: Tesla (TSLA) — P/E of 70
Investors pay a premium expecting massive future growth in the EV and energy sectors.
Negative or No P/E
Company is unprofitable (negative earnings). P/E ratio doesn't apply or shows as "N/A".
Example: Uber (early years) — No P/E
Growth companies often operate at a loss initially while investing in expansion.
How to Use P/E Ratio in Investing
1. Compare to Industry Average
Don't compare tech stocks to utility stocks—compare apples to apples.
Tech Sector Average: P/E ~30
High growth expectations
Utilities Average: P/E ~15
Stable, low growth
2. Compare to Company's Historical P/E
Is the stock trading above or below its typical valuation?
Microsoft's 10-year average P/E: 28
Current P/E: 35
→ Trading above historical average (potentially overvalued)
3. Consider Growth Rate (PEG Ratio)
PEG Ratio = P/E Ratio ÷ Annual Earnings Growth Rate
Company A: P/E of 30, Growth of 30% → PEG = 1.0 (Fair)
Company B: P/E of 30, Growth of 10% → PEG = 3.0 (Overvalued)
PEG under 1.0 = Potentially undervalued | PEG over 2.0 = Potentially overvalued
P/E Ratio Limitations
❌ Doesn't Account for Debt
Two companies with identical P/E ratios could have very different debt levels, affecting their financial health and risk profile.
❌ Not Useful for Unprofitable Companies
Many growth companies (like Amazon in its early years) have no earnings, making P/E ratio meaningless.
❌ Can Be Manipulated
Companies can use accounting tricks to temporarily boost earnings, making the P/E look artificially low.
❌ Varies Widely by Industry
A "good" P/E for a bank (10-15) would be terrible for a software company (25-40). Always compare within the same sector.
Common Questions
Is a lower P/E always better?
Not necessarily. A low P/E could mean a bargain, or it could mean the company has problems and limited growth prospects. Context matters!
What's a "good" P/E ratio?
There's no universal answer. The S&P 500 average is around 15-16, but tech stocks often trade at 30-40+, while value stocks might be 8-12. Compare to industry peers.
Forward P/E vs Trailing P/E?
Trailing P/E uses past 12 months earnings (historical data).Forward P/E uses estimated future earnings (analyst predictions). Forward P/E is more predictive but less reliable.
Key Takeaways
- ✓P/E Ratio = Stock Price ÷ Earnings Per Share
- ✓Shows how much investors pay for each dollar of earnings
- ✓Compare P/E ratios within the same industry, not across sectors
- ✓Low P/E can mean value or problems; high P/E can mean growth or overvaluation
- ✓Use P/E as one tool among many—never rely on it alone