The Price-to-Earnings (P/E) ratio is the most widely used stock valuation metric. It divides the current stock price by earnings per share (EPS) to show how much investors are paying for each dollar of earnings.
Formula: > P/E Ratio = Market Price per Share ÷ Earnings per Share (EPS)
Types: - Trailing P/E: Uses last 12 months of actual earnings (most common). - Forward P/E: Uses next 12 months of projected earnings (requires estimates).
Interpretation: - High P/E: Investors expect high growth; stock may be expensive relative to current earnings. - Low P/E: Slower growth expected; may be cheap (value stock) or struggling company. - Negative P/E: Company losing money; P/E not meaningful.
Typical ranges: - S&P 500 historical average P/E: ~15–17×. - Growth stocks: P/E of 25–50× or more. - Value stocks: P/E below the market average. - Utilities/mature companies: P/E of 10–15×.
P/E in context: - Compare to industry peers and historical averages, not in isolation. - The PEG ratio (P/E ÷ earnings growth rate) adjusts for growth — PEG < 1 often indicates undervaluation.
Limitations: EPS can be manipulated through accounting choices; P/E doesn't reflect balance sheet health; not meaningful for unprofitable companies.
> Exam tip: P/E = price ÷ EPS. Higher P/E = growth expectations (or overvaluation). Know that interest rates affect P/E — when rates rise, P/E ratios tend to compress (higher discount rate reduces present value of future earnings).