P/E Ratio
A company’s share price divided by its earnings per share.
Also called: price to earnings · price earnings ratio · pe
Written by Javier Sánchez Ros
In plain language
The P/E ratio expresses how many dollars investors pay for each dollar of annual earnings. A P/E of 25 means $25 of price per $1 of earnings.
Trailing P/E uses the last twelve months of reported earnings; forward P/E uses analyst estimates, which are forecasts and are often wrong.
A high P/E is not automatically expensive and a low one is not automatically cheap. Fast-growing companies routinely carry high multiples, and low multiples often reflect real problems.
The formula
P/E Ratio
Share Price ÷ Earnings Per Share
Worked through
Good earnings, and the stock falls 9%
- P/E before the report
- 48
- Earnings growth reported
- +22%
- Growth the price implied
- +35%
- Reaction
- −9%
Twenty-two percent growth is a good year by any ordinary standard, and the stock fell hard on it. Nothing irrational happened: at a P/E of 48 the price already contained an assumption of much faster growth, and the report was an argument against that assumption.
This is what a high multiple actually means. It is not a verdict that a stock is expensive; it is a statement about what the market has already agreed to believe. Meeting a modest expectation beats missing an extravagant one, regardless of which company is better.
For a trader the practical use is asymmetry. A richly valued stock has more room to disappoint than to surprise, which is a statement about the shape of the distribution around an event — and therefore about gap risk and position size.
What it is not is a timing tool. Multiples can stay stretched for years, and "expensive" has ended a great many short positions that were eventually correct.
Why it matters
P/E is context, not a signal. It tells you what expectations are priced in, which helps explain why a stock can fall on good news.
Common mistakes
- Comparing P/E ratios across industries with completely different growth profiles.
- Using P/E on companies with negative or barely positive earnings, where it is meaningless.
- Treating a low P/E as a trade signal on its own.
Keep exploring
These concepts are connected. Understanding one usually makes the next one easier.
A company’s net profit divided by its number of outstanding shares.
A company’s scheduled quarterly disclosure of financial results.
The total market value of a company’s shares — share price times shares outstanding.
A unit of ownership in a company.
A cash payment distributed to shareholders out of company profits.