P/E Ratio (Price-to-Earnings)
The P/E ratio is a valuation metric comparing a company's stock price to its earnings per share, used to assess whether a stock is overvalued or undervalued relative to its earnings.
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Exam Tip
P/E = Price / EPS. Higher P/E = investors expect more growth. Compare within same industry.
What is the P/E Ratio?
The Price-to-Earnings (P/E) ratio is one of the most widely used stock valuation metrics. It tells you how much investors are willing to pay for each dollar of a company's earnings.
P/E Formula
P/E Ratio = Stock Price / Earnings Per Share (EPS)
Example
- Stock Price: $50
- EPS: $2.50
- P/E Ratio = $50 / $2.50 = 20
This means investors pay $20 for every $1 of earnings.
Types of P/E Ratios
| Type | Uses | Description |
|---|---|---|
| Trailing P/E | Past 12 months EPS | Most common, based on actual results |
| Forward P/E | Projected EPS | Based on analyst estimates |
| Shiller P/E (CAPE) | 10-year avg inflation-adjusted EPS | Smooths out business cycles |
Interpreting P/E
| P/E Level | General Interpretation |
|---|---|
| Low (< 15) | Potentially undervalued or slow growth expected |
| Average (15-25) | Fairly valued for most industries |
| High (> 25) | High growth expected or potentially overvalued |
Important Considerations
- Compare within industries - Tech stocks have higher P/Es than utilities
- Growth matters - High-growth companies justify higher P/Es
- Earnings quality - One-time items can distort P/E
- Negative earnings - P/E is meaningless if company has losses
P/E vs. Other Metrics
| Metric | Best For |
|---|---|
| P/E | Profitable companies |
| P/S (Price-to-Sales) | Unprofitable growth companies |
| P/B (Price-to-Book) | Asset-heavy businesses |
| EV/EBITDA | Comparing with different capital structures |
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