P/E Ratio = Share Price ÷ Earnings Per Share (EPS)
The Short Version
The P/E ratio is the single most commonly cited valuation metric in investing. It tells you how much investors are willing to pay today for each dollar of a company's earnings. A 'high' P/E often signals that the market expects strong future growth (or that the stock is overpriced); a 'low' P/E can signal a bargain (or that the market expects trouble ahead). P/E only makes sense compared against something — the company's own history, its industry peers, or the broader market.
Explain It Like I'm 10
Imagine a lemonade stand is for sale for $200, and it made $20 in profit last year. To see if that's a fair price, you could ask: 'how many years of $20 profit would it take to earn back my $200?' Answer: 10 years ($200 ÷ $20). That number — 10 — is basically a P/E ratio. It tells you how many years of current profit you're paying for upfront when you buy in at today's price.
Step-by-Step Example
- 1 Stock price: $60 per share.
- 2 EPS (profit per share): $3.
- 3 Divide: $60 ÷ $3 = 20. The P/E ratio is 20.
- 4 This means investors are paying $20 today for every $1 the company currently earns per year.
- 5 Compare it: a similar company with a P/E of 10 is 'cheaper' per dollar of profit — but only if both companies are expected to keep growing at a similar pace. A high P/E can be justified if a company is growing fast; a low P/E might mean investors expect trouble ahead.
A stock trading at $60 with an EPS of $3 has a P/E ratio of 20 — meaning investors are paying $20 for every $1 of annual earnings.
Quick Recap
- ✓ Trailing P/E uses past (actual) earnings; forward P/E uses projected future earnings.
- ✓ Compare P/E within the same industry — a software company and a utility company have very different 'normal' P/E ranges.
- ✓ A stock can have no P/E (or a negative one) if the company has no earnings or is losing money.