Definition
The price-to-earnings ratio (P/E) compares a company's share price with its earnings per share, showing how many dollars investors pay for each $1 of the company's yearly profit.
How it works
The basic formula is P/E = share price ÷ earnings per share (EPS). You get the same result from market cap ÷ net income, because both parts are simply multiplied by the number of shares. A trailing P/E uses the reported earnings of the last 12 months. A forward P/E uses estimates for the next 12 months, so it depends on forecasts that may turn out wrong.
P/E is used to compare how the market values one dollar of profit at different companies or at different times. A higher number usually means investors expect faster earnings growth or see the profit as more stable. A lower number can reflect slow growth, higher risk or a temporary drop in the share price. Normal levels differ a lot between industries, so comparisons are most useful within the same industry and against the company's own history.
The ratio has clear limits. When a company makes a loss, the P/E is negative and is usually shown as not meaningful. One-off gains or charges can distort a single year's earnings. A high P/E does not automatically mean a stock is overvalued, and a low P/E does not prove it is cheap.
Example (hypothetical numbers)
Suppose Company X trades at $60 per share and earned $3 per share over the last 12 months.
P/E = $60 ÷ $3 = 20, so investors pay $20 for each $1 of yearly earnings.
Check with totals: 500,000,000 shares × $60 = $30,000,000,000 market cap, and net income of $1,500,000,000 gives $30,000,000,000 ÷ $1,500,000,000 = 20.
Company Y trades at only $30 but earned $1 per share, so its P/E is $30 ÷ $1 = 30.
Company Y has the lower share price, yet the market pays more for each dollar of its earnings.
Common mistakes
- Comparing P/E ratios of companies in very different industries as if the same level were normal for all.
- Reading a high P/E as proof of overvaluation without looking at expected growth.
- Mixing trailing and forward P/E figures in the same comparison.
- Relying on a P/E calculated from earnings that include a large one-off gain or charge.
Related calculators
This glossary is for education only and is not investment advice. Examples use hypothetical numbers.