P/E Ratio Definition: Price-to-Earnings

Ratio Formula and Examples

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

The price-to-earnings (P/E) ratio measures a company's share price relative to its earnings per
share (EPS). Often called the price or earnings multiple, the P/E ratio helps assess the relative
value of a company's stock. It's handy for comparing a company's valuation against its
historical performance, against other firms within its industry, or the overall market.

P/E can be estimated on a trailing (backward-looking) or forward (projected) basis.

Key Takeaways

 The price-to-earnings (P/E) ratio is the proportion of a company's share price to its earnings
per share.
 A high P/E ratio could mean that a company's stock is overvalued or that investors expect
high growth rates.
 Companies with no earnings or are losing money don't have a P/E ratio because there's
nothing to put in the denominator.
 The two most used P/E ratios are forward and trailing P/E.
 P/E ratios are most valuable when comparing similar companies in the same industry or for a
single company over time.

P/E Ratio Formula and Calculation

The formula and calculation are as follows:

To determine the P/E value, divide the stock price by the EPS.

The stock price (P) can be found simply by searching a stock’s ticker on a reputable financial
website. Although this concrete value reflects what investors currently pay for the stock, the
EPS is related to earnings reported at different times.

EPS is generally given in two ways. Trailing 12 months (TTM) represents the company's
performance over the past 12 months. Another is found in earnings releases, which often
provide EPS guidance. This is the company's advice on what it expects in future earnings.
These different versions of EPS form the basis of trailing and forward P/E, respectively.

Understanding the P/E Ratio

The P/E ratio is one of the most widely used by investors and analysts reviewing a stock's
relative valuation. It helps to determine whether a stock is overvalued or undervalued. A
company's P/E can also be benchmarked against other stocks in the same industry or against
the broader market, such as the S&P 500 Index.

Analysts interested in long-term valuation trends can look at the P/E 10 or P/E 30 measures,
which average the past 10 or 30 years of earnings. These measures are often used when trying
to gauge the overall value of a stock index, such as the S&P 500, because these longer-term
metrics can show overall changes through several business cycles.

The P/E ratio of the S&P 500 going back to 1927 has had a low of 5.9 in mid-1949 and been
as high as 122.4 in mid-2009, right after the financial crisis. The long-term average P/E for
the S&P 500 is about 17.6, meaning that the stocks that make up the index have collectively
been priced at more than 17 times greater than their weighted average earnings.1 This
average can serve as a benchmark for whether the market is valued higher or lower than
historical norms.

Analysts and investors review a company's P/E ratio to determine if the share price accurately
represents the projected earnings per share.

Forward Price-to-Earnings

The most commonly used P/E ratios are the forward P/E and the trailing P/E. A third and less
typical variation uses the sum of the last two actual quarters and the estimates of the
following two quarters.

The forward (or leading) P/E uses future earnings guidance rather than trailing figures.
Sometimes called "estimated price to earnings," this forward-looking indicator helps compare
current earnings to future earnings and can clarify what earnings will look like without
changes and other accounting adjustments.

However, there are problems with the forward P/E metric— namely, companies could
underestimate earnings to beat the estimated P/E when the next quarter's earnings arrive.
Furthermore, external analysts may also provide estimates that diverge from the company
estimates, creating confusion.

Trailing Price-to-Earnings

The trailing P/E relies on past performance by dividing the current share price by the total
EPS for the previous 12 months. It's the most popular P/E metric because it's thought to be
objective—assuming the company reported earnings accurately. But the trailing P/E also has
its share of shortcomings, including that a company’s past performance doesn’t necessarily
determine future earnings.

Investors often base their purchases on potential earnings, not historical performance. Using
the trailing P/E ratio can be a problem because it relies on a fixed earnings per share (EPS)
figure, while stock prices are constantly changing. This means that if something significant
affects a company's stock price, either positively or negatively, the trailing P/E ratio won't
accurately reflect it. In essence, it might not provide an up-to-date picture of the company's
valuation or potential.

The trailing P/E ratio will change as the price of a company’s stock moves because earnings
are released only each quarter, while stocks trade whenever the market is open. As a result,
some investors prefer the forward P/E. If the forward P/E ratio is lower than the trailing P/E
ratio, analysts are expecting earnings to increase; if the forward P/E is higher than the current
P/E ratio, analysts expect them to decline.

Valuation From P/E

In addition to indicating whether a company’s stock price is overvalued or undervalued, the

P/E ratio can reveal how a stock’s value compares with its industry or a benchmark like the
S&P 500.

The P/E ratio indicates the dollar amount an investor can expect to invest in a company to
receive $1 of that company’s earnings. Hence, it’s sometimes called the price multiple
because it shows how much investors are willing to pay per dollar of earnings. If a company
trades at a P/E multiple of 20x, investors are paying $20 for $1 of current earnings.

The P/E ratio also helps investors determine a stock’s market value compared with
the company’s earnings. That is, the P/E ratio shows what the market is willing to pay today
for a stock based on its past or future earnings. A high P/E ratio could signal that a stock’s
price is high relative to earnings and is overvalued. Conversely, a low P/E could indicate that
the stock price is low relative to earnings.

Examples of the P/E Ratio

Let's clarify this with an example, looking at FedEx Corporation (FDX). We can calculate the
P/E ratio for FDX as of Feb. 9, 2024, when the company's stock price closed at $242.62. The
company's earnings per share (EPS) for the trailing 12 months was $16.85.2

Therefore, FDX's P/E ratio was as follows:

$242.62 / $16.85 = 14.40

Comparing Companies Using P/E

Let's now look at two energy companies to see their relative values.

Hess Corporation (HES) had the following data at the close of Feb. 9, 2024. We'll use the
diluted EPS to account for what would occur should all convertible securities be exercised:

 Stock price: $142.07

 Diluted 12 months trailing EPS: $4.49
 P/E: 31.64 ($142.07 / $4.49)3
HES thus traded at about 31 times trailing earnings. However, the P/E of 31 isn't helpful
unless you have something to compare it with, like the stock's industry group, a benchmark
index, or HES's historical P/E range.

HES's P/E ratio was higher than the S&P 500, which, as of Feb. 9, 2024, was about 22 times
12-month trailing earnings.4 To compare HES's P/E ratio to a peer, let's look at Marathon
Petroleum Corporation (MPC):

 Stock price: $169.97

 Diluted 12 months trailing EPS: $23.64
 P/E: 7.195

When you compare HES's P/E of 31 to MPC's of 7, HES's stock could appear substantially
overvalued relative to the S&P 500 and MPC. Alternatively, HES's higher P/E might mean
that investors expect much higher earnings growth in the future than MPC.

However, no ratio can tell you everything you need about a stock. Before investing, it's wise
to use various financial tools to determine whether a stock is fairly valued.

Investor Expectations

In general, a high P/E suggests that investors expect higher earnings growth than those with a
lower P/E. A low P/E can indicate that a company is undervalued or that a firm is doing
exceptionally well relative to its past performance. When a company has no earnings or is
posting losses, the P/E is expressed as N/A. Though it's possible to calculate a negative P/E,
it's not common.

The P/E ratio can also standardize the value of $1 of earnings throughout the stock market. In
theory, by taking the median of P/E ratios over a period of several years, one could formulate
something of a standardized P/E ratio, which could then be seen as a benchmark and used to
indicate whether a stock is worth buying.

N/A Meaning

A P/E ratio of N/A means the ratio is unavailable for that company's stock. A company can
have a P/E ratio of N/A if it's newly listed on the stock exchange and has not yet reported
earnings, such as with an initial public offering. It could also mean a company has zero or
negative earnings.

P/E vs. Earnings Yield

The inverse of the P/E ratio is the earnings yield (which can be thought of as the
earnings/price ratio). The earnings yield is the EPS divided by the stock price, expressed as a
percentage.

If Stock A is trading at $10, and its EPS for the past year is 50 cents (TTM), it has a P/E of 20
(i.e., $10 / 50 cents) and an earnings yield of 5% (50 cents / $10). If Stock B is trading at $20
and its EPS (TTM) is $2, it has a P/E of 10 (i.e., $20 / $2) and an earnings yield of 10% ($2 /
$20).

The earnings yield is not as widely used as the P/E ratio. Earnings yields are useful if you're
concerned about the rate of return on investment. For equity investors who earn periodic
investment income, this may be a secondary concern. This is why many investors may prefer
value-based measures like the P/E ratio or stocks.
The earnings yield is also helpful when a company has zero or negative earnings. Since this is
common among high-tech, high-growth, or startup companies, EPS will be negative and
listed as an undefined P/E ratio (denoted as N/A). If a company has negative earnings,
however, it would have a negative earnings yield, which can be used for comparison.

P/E vs. PEG Ratio

A P/E ratio, even one calculated using a forward earnings estimate, doesn’t always tell you
whether the P/E is appropriate for the company’s expected growth rate. To address this,
investors turn to the price/earnings-to-growth ratio, or PEG.

The PEG ratio measures the relationship between the price/earnings ratio and earnings
growth to give investors a complete picture. Investors use it to see if a stock’s
price is overvalued or undervalued by analyzing earnings and the expected growth rate for the
company. The PEG ratio is calculated as a company’s trailing price-to-earnings (P/E) ratio
divided by its earnings growth rate for a given period.

Since it’s based on both trailing earnings and future earnings growth, PEG is often viewed as
more informative than the P/E ratio. For example, a low P/E ratio could suggest a stock is
undervalued and worth buying. However, including the company’s growth rate to get its PEG
ratio might tell a different story. PEG ratios can be termed “trailing” if using historical
growth rates or “forward” if using projected growth rates.

Although earnings growth rates can vary among different sectors, a stock with a PEG of less
than one is typically considered undervalued because its price is low relative to its
expected earnings growth. A PEG greater than one might be considered overvalued because it
suggests the stock price is too high relative to the company’s expected earnings growth.6

Absolute vs. Relative P/E

Analysts also distinguish between absolute P/E and relative P/E ratios in their analyses.

Absolute P/E

The numerator of this ratio is usually the current stock price, and the denominator may be
the trailing EPS (TTM), the estimated EPS for the next 12 months (forward P/E), or a mix of
the trailing EPS of the last two quarters and the forward P/E for the next two quarters.

When distinguishing absolute P/E from relative P/E, remember that absolute P/E represents
the P/E of the current period. For example, if the stock price today is $100 and the TTM
earnings are $2 per share, the P/E is 50 = ($100 / $2).

Relative P/E

The relative P/E compares the absolute P/E to a benchmark or a range of past P/Es over a
relevant period, such as the past 10 years. The relative P/E shows what portion or percentage
of the past P/Es that the current P/E has reached. The relative P/E usually compares the
current P/E value with the highest value of the range. Investors might also compare the
current P/E to the bottom side of the range, measuring how close the current P/E is to the
historic low.

The relative P/E will have a value below 100% if the current P/E is lower than the past value
(whether the past high or low). If the relative P/E measure is 100% or more, this tells
investors that the current P/E has reached or surpassed the past value.
Limitations of Using the P/E Ratio

Like any other fundamental metric, the price-to-earnings ratio comes with a few limitations
that are important to understand. Companies that aren't profitable and have no earnings—or
negative earnings per share—pose a challenge for calculating P/E. Views among analysts
vary about how to deal with this. Some say there is a negative P/E, others assign a P/E of 0,
while most just say the P/E doesn't exist (N/A) until a company becomes profitable.

A main limitation of using P/E ratios is for comparing the P/E ratios of companies from
varied sectors. Companies' valuation and growth rates often vary wildly between industries
because of how and when the firms earn their money.

As such, one should only use P/E as a comparative tool when considering companies in the
same sector because this is the only kind that will provide worthwhile results. For example,
comparing the P/E ratios of a telecommunications company and the P/E of an oil and gas
drilling company could suggest one is the superior investment, but that's not a cogent
conclusion. An individual company’s high P/E ratio, for example, would be less cause for
concern when the entire sector has high P/E ratios.

Other P/E Considerations

Because a company’s debt can affect both share price and earnings, leverage can skew P/E
ratios as well. For example, suppose two similar companies differ in the debt they hold. The
firm with more debt will likely have a lower P/E value than the one with less debt. However,
if the business is solid, the one with more debt could have higher earnings because of the
risks it has taken.

Another critical limitation of price-to-earnings ratios lies within the formula for calculating
P/E. P/E ratios rely on accurately presenting the market value of shares and earnings per
share estimates. The market determines the prices of shares available in many places.
However, the source of earnings information is the company itself. Thus, it’s possible it could
be manipulated, so analysts and investors have to trust the company’s officers to provide
genuine information. The stock will be considered riskier and less valuable if that trust is
broken.

To reduce these risks, the P/E ratio is only one measurement analysts review. If a company
were to manipulate its results intentionally, it would be challenging to ensure all the metrics
were aligned in how they were changed. That’s why the P/E ratio continues to be a central
data point when analyzing public companies, though by no means is it the only one.

What Is a Good Price-to-Earnings Ratio?

The answer depends on the industry. Some industries tend to have higher average price-to-
earnings ratios. For example, in February 2024, the Communications Services Select Sector
Index had a P/E of 17.60, while it was 29.72 for the Technology Select Sector Index.78 To
get a general idea of whether a particular P/E ratio is high or low, compare it to the average
P/E of others in its sector, then other sectors and the market.

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

Many investors say buying shares in companies with a lower P/E ratio is better because you
are paying less for every dollar of earnings. A lower P/E ratio is like a lower price tag,
making it attractive to investors looking for a bargain. In practice, however, there could be
reasons behind a company’s particular P/E ratio. For instance, if a company has a low P/E
ratio because its business model is declining, the bargain is an illusion.

What Does a P/E Ratio of 15 Mean?

A P/E ratio of 15 means that the company’s current market value equals 15 times its annual
earnings. Put literally, if you were to hypothetically buy 100% of the company’s shares, it
would take 15 years for you to earn back your initial investment through the company’s
ongoing profits. However, that 15-year estimate would change if the company grows or its
earnings fluctuate.

The Bottom Line

The P/E ratio is one of many fundamental financial metrics for evaluating a company. It's
calculated by dividing the current market price of a stock by its earnings per share. It
indicates investor expectations, helping to determine if a stock is overvalued or undervalued
relative to its earnings. The P/E ratio helps compare companies within the same industry, like
insurance company to insurance company or telecom to telcom. It offers insights into market
sentiment and investment prospects. However, it should be used with other financial
measures since it doesn't account for future growth prospects, debt levels, or industry-specific
factors.