The Price-to-Earnings Ratio

The price-to-earnings ratio — usually written P/E — is one of the most widely cited numbers in investing. The math behind it is simple division, but understanding what the result means takes a bit more thought.

The Formula

$$\text{P/E} = \frac{\text{Stock Price}}{\text{Earnings Per Share (EPS)}}$$

Stock price is the current market price of one share. Earnings per share (EPS) is the company's annual profit divided by the total number of shares outstanding. Divide the price by the EPS and you get the P/E ratio.

Example

A stock trades at $48 per share. The company earned $3.00 per share over the past year.

$$\text{P/E} = \frac{48}{3.00} = 16$$

The P/E ratio is 16. One way to interpret this: investors are paying $16 for every $1 of annual earnings the company produces. Another way to read it: at current earnings, it would take 16 years of profits to equal the purchase price — so P/E is sometimes called the payback period in years, assuming earnings stay flat.

Trailing vs. Forward P/E

Trailing P/E uses actual reported earnings from the past 12 months (sometimes written "TTM" for trailing twelve months). It's based on known data.

Forward P/E uses estimated earnings for the next 12 months. It's based on analyst projections, so it carries more uncertainty.

Comparing the two gives a quick read on expected growth. If a stock has a trailing P/E of 20 and a forward P/E of 15, the market expects earnings to grow — the denominator is projected to get bigger, bringing the ratio down.

What P/E Tells You

A high P/E means investors are paying a lot relative to current earnings — typically because they expect strong future growth. A low P/E might mean the stock is inexpensive, or that the market expects declining earnings.

Neither is automatically good or bad. P/E is most useful when compared to:

The company's own historical P/E
Competitors in the same industry
A broad market benchmark

Industries have very different typical P/E ranges. Utilities and banks often trade in the single digits or low teens; technology and growth companies often trade at 30, 50, or higher. Comparing a bank's P/E to a software company's is not especially meaningful.

P/E Calculator

Stock price ($)

Earnings per share ($)

Practice Problems

1. A stock trades at $72 per share. The company earned $4.50 per share last year. What is the trailing P/E? Show answer$\text{P/E} = \frac{72}{4.50} = 16$.

2. Company A has a stock price of $30 and EPS of $2.00. Company B has a stock price of $90 and EPS of $9.00. Which has the higher P/E, and what does that suggest? Show answerCompany A: $30/2 = 15$. Company B: $90/9 = 10$. Company A has the higher P/E — investors are paying more per dollar of earnings, suggesting they expect stronger future growth from Company A (or that Company A is overvalued relative to Company B).

3. A company has a trailing P/E of 25 and a forward P/E of 18. What does this imply about expected earnings? Show answerThe forward P/E is lower, which means the denominator (earnings) is expected to grow. The market anticipates earnings will increase enough to bring the ratio from 25 down to 18.