Price-to-earnings ratio (P/E)
Also called Earnings multiple
A valuation measure that compares a stock’s price to the company’s profit per share, showing how much investors pay for each dollar of earnings.
What it means
The P/E ratio divides a company’s share price by its earnings per share. A trailing P/E uses the past 12 months of reported earnings, while a forward P/E uses analysts’ estimates for the year ahead. The same idea can be applied to a whole index by comparing its total price to its total earnings.
A high P/E can mean investors expect strong growth, or that the stock is expensive; a low P/E can signal a bargain or a business with real problems. P/E is most useful when comparing similar companies or a company to its own history. It does not work for firms with losses, and earnings can be distorted by one-time items or accounting choices.
Formula
P/E = share price ÷ earnings per share
- Share price = the current market price of one share
- Earnings per share = net income ÷ shares outstanding
Example
For example, a stock trading at $50 whose company earned $2.50 per share has a P/E of $50 ÷ $2.50 = 20, meaning investors are paying $20 for each $1 of annual earnings.
How it’s used
- Comparing the valuation of companies in the same industry
- Gauging whether a market index looks expensive versus its history
- Screening stocks for further research
Related terms
Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.