P/E Ratio

How much you pay for each dollar of company profits

Understanding the price-to-earnings ratio for evaluating if a stock is expensive or cheap
Modified

September 7, 2025

Category: Analysis & Research
Difficulty: Beginner

Definition

A number that tells you how expensive a stock is compared to the company’s profits. It’s calculated by dividing the stock price by the earnings per share.

Simple Formula

P/E Ratio = Stock Price á Earnings per Share

Example

  • Stock price: $50
  • Earnings per share: $5
  • P/E ratio: 50 á 5 = 10

This means you’re paying $10 for every $1 of company profits.

How to Interpret P/E Ratios

High P/E (Above 20-25)

What it might mean: - Investors expect the company to grow fast - The stock might be expensive - People are excited about the company’s future

Examples: Fast-growing tech companies, hot new businesses

Low P/E (Below 15)

What it might mean: - The stock might be a bargain - People think the company has problems - The business might be declining

Examples: Older industries, companies with troubles

Average P/E (15-20)

  • Fairly valued compared to typical stocks
  • Neither particularly expensive nor cheap

Types of P/E Ratios

Trailing P/E

  • Uses last 12 months of actual profits
  • Based on real numbers that already happened
  • Most common type you’ll see

Forward P/E

  • Uses predictions of next year’s profits
  • Based on analyst guesses
  • Could be wrong if predictions are off

What’s a “Good” P/E?

It Depends On:

  • Industry: Tech stocks usually higher than utility stocks
  • Growth rate: Fast-growing companies often have higher P/E
  • Market conditions: Bull markets = higher P/E ratios
  • Company’s situation: Temporary problems can make P/E look weird

General Guidelines:

  • Very high (above 30): Possibly expensive or very fast growth expected
  • Moderate (15-25): Typical for many established companies
  • Low (below 15): Possibly cheap or has problems
  • Very low (below 10): Either great value or serious issues

Common P/E Ranges by Industry

  • Technology: Often 20-40+
  • Healthcare: Often 15-30
  • Banks: Often 8-15
  • Utilities: Often 12-18
  • Retail: Often 12-25

Limitations

When P/E Doesn’t Work Well

  • No profits: Can’t calculate P/E if company loses money
  • Weird one-time events: Big one-time gains or losses mess up the ratio
  • Very cyclical businesses: Profits go up and down a lot

Other Things to Consider

  • P/E is just one measure - don’t use it alone
  • Compare companies in the same industry
  • Look at the company’s growth rate
  • Consider the overall business quality

PEG Ratio (Bonus Concept)

PEG = P/E Ratio á Growth Rate

Example:

  • P/E ratio: 20

  • Growth rate: 20% per year

  • PEG: 20 á 20 = 1.0

  • PEG below 1.0: Potentially good value

  • PEG above 1.0: Potentially expensive

Simple Investment Rules

Value Investors Like:

  • Low P/E ratios (with good reasons)
  • P/E lower than industry average
  • P/E lower than company’s historical average

Growth Investors Accept:

  • Higher P/E ratios if company is growing fast
  • Focus on PEG ratio instead of just P/E
  • Future potential over current valuation

Red Flags:

  • P/E much higher than similar companies
  • P/E keeps getting higher while business stays same
  • Very low P/E with declining business

External Resources