What Is the Price-to-Earnings (P/E) Ratio?

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What Is the Price-to-Earnings (P/E) Ratio?

Let me explain the price-to-earnings (P/E) ratio directly: it measures a company's share price relative to its earnings per share (EPS). You might hear it called the price or earnings multiple, and it's a tool I use to assess the relative value of a company's stock. This ratio is particularly useful when you're comparing a company's valuation against its own historical performance, against competitors in the same industry, or even against the broader market.

Key Takeaways on P/E Ratio

Understand this: the P/E ratio is simply the proportion of a company's share price to its EPS. If you see a high P/E, it could mean the stock is overvalued or that investors are betting on high growth rates ahead. Companies without earnings or those losing money don't have a P/E ratio because there's no positive denominator to work with. The two main types you'll encounter are forward and trailing P/E. Remember, P/E ratios are most valuable when you're comparing similar companies in the same industry or tracking a single company over time.

How the Price-to-Earnings (P/E) Ratio Works

The P/E ratio is one of the most common tools investors and analysts like me use to review a stock's relative valuation. It helps you figure out if a stock is overvalued or undervalued. You can benchmark a company's P/E against others in its industry or the overall market. If you're looking at long-term trends, consider P/E 10 or P/E 30, which average earnings over the past 10 or 30 years. These are handy for gauging the value of something like the S&P 500 through multiple business cycles. For context, the S&P 500's P/E has ranged from a low of about 6 in 1949 to a high of 122 in 2009, and as of June 2025, it stood at 29.46.

P/E Ratio Formula and Calculation

Here's the straightforward formula: P/E Ratio = Market value per share / Earnings per share. To calculate it, you divide the stock price by the EPS. You can find the stock price (P) by looking up the ticker on any financial site. EPS comes in forms like trailing 12 months (TTM), which covers the past year, or forward estimates from earnings releases. These lead to trailing and forward P/E ratios respectively.

When to Review the P/E Ratio

You should review a company's P/E ratio to check if the share price accurately reflects the projected EPS. The common types are forward P/E and trailing P/E, with a less common one mixing recent actuals and estimates.

Forward P/E

Forward P/E uses future earnings guidance instead of past figures. It's sometimes called estimated price to earnings, and it helps you compare current earnings to what might come without accounting tweaks. But watch out: companies might lowball estimates to beat them later, and external analysts' figures could differ, causing confusion.

Trailing P/E

Trailing P/E divides the current share price by the total EPS from the previous 12 months. It's popular because it's based on actual reported earnings, assuming they're accurate. However, past performance doesn't guarantee future results, and since stock prices fluctuate daily while earnings are quarterly, it might not capture recent changes. If the forward P/E is lower than trailing, expect earnings growth; if higher, a decline.

Valuation From P/E

Beyond spotting over or undervaluation, the P/E shows how a stock's value stacks up against its industry or a benchmark like the S&P 500. It tells you the dollar amount investors pay for $1 of earnings— a 20x P/E means $20 for $1 of earnings. A high P/E might mean the stock is pricey relative to earnings, while a low one suggests it's cheap.

Examples of the P/E Ratio

Take FedEx (FDX) as an example: on August 8, 2025, its stock closed at $228.05 with a TTM EPS of $16.81, giving a P/E of 13.57. Now compare Marathon Petroleum (MPC) at $160.84 stock price and $6.88 diluted EPS, for a P/E of 23.38, against Hess Midstream (HESM) at $41.64 and $2.69 EPS, for 15.48. MPC looks overvalued next to HESM but aligns with the S&P 500's 24. Use multiple tools before deciding.

Investor Expectations

A high P/E generally means investors expect strong earnings growth, while a low one could signal undervaluation or solid performance relative to history. For companies with losses, P/E is N/A. You can use median P/Es over years as a benchmark for buying decisions.

N/A Meaning

N/A for P/E means the ratio isn't available, often for new listings without earnings reports or companies with zero/negative earnings.

P/E vs. Earnings Yield

Earnings yield is the inverse: EPS divided by stock price, as a percentage. It's useful for return on investment, especially with negative earnings where P/E is N/A.

P/E vs. PEG Ratio

PEG ratio divides P/E by earnings growth rate for a fuller picture. A PEG under 1 suggests undervaluation; over 1, overvaluation. It can be trailing or forward.

Absolute vs. Relative P/E

Absolute P/E uses current figures. Relative P/E compares it to historical ranges, showing percentage of past highs or lows.

Limitations of Using the P/E Ratio

P/E struggles with unprofitable companies—views differ on handling negatives. It's not comparable across sectors due to varying growth and earnings patterns. Debt can skew it, and it relies on potentially manipulable company data. Always combine with other metrics.

Other P/E Considerations

Leverage affects P/E through debt's impact on price and earnings. Earnings sources must be trusted, as manipulation risks devalue the stock.

Alternatives to P/E Ratios

Consider price-to-book (P/B) for asset-heavy firms, price-to-sales (P/S) for unprofitable or volatile ones, or EV/EBITDA for a debt-inclusive view in capital-intensive sectors.

What Is a Good Price-to-Earnings (P/E) Ratio?

It varies by industry—compare within sectors. For example, in August 2025, communications was at 19.46, tech at 30.20.

Is It Better to Have a Higher or Lower P/E Ratio?

Lower P/E often means better value, but context matters; a low one might indicate declining business.

What Does a P/E Ratio of 15 Mean?

It means the market values the company at 15 times its annual earnings, implying 15 years to recoup investment via profits, assuming no changes.

What Is the Difference Between Forward P/E and Trailing P/E?

Trailing uses past 12 months' EPS; forward uses projections for the next 12.

What Are the Limitations of the P/E Ratio?

It ignores growth, can be manipulated, isn't cross-industry comparable, and overlooks debt or cash flow.

The Bottom Line

The P/E ratio, calculated as stock price over EPS, gauges investor expectations and helps spot over/undervaluation within industries. Use it alongside other metrics, as it doesn't cover growth, debt, or sector specifics.

What Is the Price-to-Earnings (P/E) Ratio?

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