The price-to-earnings ratio is the most common valuation metric, but it is frequently misunderstood. Learn how to use it properly.
The price-to-earnings (P/E) ratio is the most widely referenced valuation metric in investing. It is simple to calculate but often misinterpreted.
P/E Ratio = Stock Price / Earnings Per Share (EPS)
It tells you how much investors are paying for each dollar of earnings.
A P/E of 20 means investors pay $20 for every $1 of annual earnings.
Neither is inherently better; experienced investors look at both.
A high P/E suggests investors expect higher earnings growth in the future. A low P/E may indicate the company is undervalued or that earnings are expected to decline.
However, P/E alone does not tell you if a stock is "cheap" or "expensive." You must consider:
PEG = P/E / Earnings Growth Rate
A PEG near 1 suggests fair value relative to growth. Below 1 may indicate undervaluation. This is most useful for growing companies.
If a company has no earnings, P/E is meaningless. Use other metrics like price-to-sales or EV/EBITDA.
Manufacturers and commodity companies often look cheap at peak earnings (low P/E) and expensive at troughs (high P/E). This is the "cyclical trap."
A large gain or loss can distort EPS. Use adjusted or normalized earnings but verify the adjustments are legitimate.
Buybacks reduce share count, boosting EPS without any operational improvement. A falling P/E may simply reflect financial engineering.
Average P/E varies dramatically by sector:
Always compare a company's P/E to its peers, not the broad market.
SharesLocker displays P/E and other valuation metrics derived from current market data and SEC filings alongside change analysis. Rather than looking at a static P/E in isolation, you can see how the underlying earnings have changed across filing periods.