What a P/E ratio is
The price-to-earnings ratio is the most quoted number for judging whether a share looks expensive. Here is how it works and where it misleads.
You will often hear that a stock "trades at 25 times earnings". That is its P/E ratio. It is the most common quick measure of how expensive a share is.
How it is worked out
P/E stands for price to earnings. Take the share price and divide it by the company's profit per share over a year.
If a share costs $50 and the company earned $2 per share, the P/E is 25. In plain terms, buyers are paying $25 for every $1 of yearly profit.
Two versions
- Trailing P/E uses the profit from the last 12 months. It is based on real results.
- Forward P/E uses analysts' forecasts for the next 12 months. It looks ahead, but forecasts can be wrong.
News reports do not always say which one they mean.
What a high or low number tells you
A high P/E usually means buyers expect profits to grow fast. A low P/E can mean the company is cheap, or that buyers expect trouble ahead.
P/E ratios also differ a lot by industry. Fast-growing technology companies usually have higher ones than banks or utilities. Comparing a company with others in the same industry tells you more than comparing it with the whole market.
Where it misleads
- A company with no profit has no P/E at all.
- A one-off gain or loss can make one year's profit unusually high or low.
- A low P/E is not a bargain if profits are about to fall.
The short version
- P/E is share price divided by yearly profit per share.
- It shows how much buyers pay for each dollar of profit.
- Compare it within an industry, and check whether it uses past or forecast profit.
This is general information, not investment advice.
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