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INVESTING FUNDAMENTAL ANALYSIS

P/E Ratio Definition: Price-

to-Earnings Ratio Formula
and Examples
By JASON FERNANDO Updated March 25, 2023

Reviewed by THOMAS BROCK

Fact checked by TIMOTHY LI

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

The price-to-earnings ratio is the ratio for valuing a
company that measures its current share price
relative to its earnings per share (EPS). The price-to-
earnings ratio is also sometimes known as the price
multiple or the earnings multiple.

P/E ratios are used by investors and analysts to

determine the relative value of a company's shares
in an apples-to-apples comparison to others in the
same sector. It can also be used to compare a
company against its own historical record or to
compare aggregate markets against one another or
over time.

P/E may be estimated on a trailing (backward-

looking) or forward (projected) basis.

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KEY TAKEAWAYS
The price-to-earnings (P/E) ratio relates 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 are expecting high growth rates in
the future.
Companies that have no earnings or that are
losing money do not have a P/E ratio
because there is nothing to put in the
denominator.
Two kinds of P/E ratios—forward and
trailing P/E—are used in practice.
A P/E ratio holds the most value to an
analyst when compared against similar
companies in the same industry or for a
single company across a period of time.

Investopedia / Xiaojie Liu

P/E Ratio Formula and Calculation

The formula and calculation used for this process
are as follows.

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Market value per share

P/E Ratio = Earnings per share

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To determine the P/E value, one must simply divide

the current stock price by the earnings per share
(EPS).

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The current stock price (P) can be found simply by

plugging a stock’s ticker symbol into any finance
website, and although this concrete value reflects
what investors must currently pay for a stock, the
EPS is a slightly more nebulous figure.

EPS comes in two main varieties. TTM is a Wall

Street acronym for "trailing 12 months". This
number signals the company's performance over the
past 12 months. The second type of EPS is found in a
company's earnings release, which often provides
EPS guidance. This is the company's best-educated
guess of what it expects to earn in the future. These
different versions of EPS form the basis of trailing
and forward P/E, respectively.

Understanding the P/E Ratio

The price-to-earnings ratio (P/E) is one of the most
widely used tools by which investors and analysts
determine a stock's relative valuation. The P/E ratio
helps one 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.

Sometimes, analysts are interested in long-term

valuation trends and consider the P/E 10 or P/E 30
measures, which average the past 10 or past 30 years
of earnings, respectively. 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 measures can compensate for changes
in the business cycle.

The P/E ratio of the S&P 500 has fluctuated from a

low of around 5x (in 1917) to over 120x (in 2009 right
before the financial crisis). The long-term average
P/E for the S&P 500 is around 16x, meaning that the
stocks that make up the index collectively command
a premium 16 times greater than their weighted
average earnings. [1]

Tip: Analysts and investors review a

company's P/E ratio when they determine
if the share price accurately represents the
projected earnings per share.

Forward Price-to-Earnings
These two types of EPS metrics factor into the most
common types of P/E ratios: the forward P/E and
the trailing P/E. A third and less common variation
uses the sum of the last two actual quarters and the
estimates of the next 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 is useful for comparing current
earnings to future earnings and helps provide a
clearer picture of what earnings will look like—
without changes and other accounting adjustments.

However, there are inherent problems with the

forward P/E metric—namely, companies could
underestimate earnings in order to beat the
estimated P/E when the next quarter's earnings are
announced. Other companies may overstate the
estimate and later adjust it going into their
next earnings announcement. Furthermore, external
analysts may also provide estimates, which may
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
earnings over the past 12 months. It's the most
popular P/E metric because it's the most objective—
assuming the company reported earnings
accurately. Some investors prefer to look at the
trailing P/E because they don't trust another
individual’s earnings estimates. But the trailing P/E
also has its share of shortcomings—namely, that a
company’s past performance doesn’t signal future
behavior.

Investors should thus commit money based on

future earnings power, not the past. The fact that the
EPS number remains constant, while the stock prices
fluctuate, is also a problem. If a major company
event drives the stock price significantly higher or
lower, the trailing P/E will be less reflective of those
changes.

The trailing P/E ratio will change as the price of a

company’s stock moves because earnings are only
released each quarter, while stocks trade day in and
day out. As a result, some investors prefer the
forward P/E. If the forward P/E ratio is lower than the
trailing P/E ratio, it means analysts are expecting
earnings to increase; if the forward P/E is higher than
the current P/E ratio, analysts expect them to
decrease.

Valuation From P/E

The price-to-earnings ratio or P/E is one of the most
widely used stock analysis tools by which investors
and analysts determine stock valuation. In addition
to showing whether a company's stock price is
overvalued or undervalued, the P/E can reveal how
a stock's valuation compares to its industry group or
a benchmark like the S&P 500 Index.

In essence, the price-to-earnings ratio indicates the

dollar amount an investor can expect to invest in a
company in order to receive $1 of that company’s
earnings. This is why the P/E is sometimes referred
to as the price multiple because it shows how much
investors are willing to pay per dollar of earnings. If a
company was currently trading at a P/E multiple of
20x, the interpretation is that an investor is willing to
pay $20 for $1 of current earnings.

The P/E ratio helps investors determine the market

value of a stock as compared to
the company's earnings. In short, 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 could
mean that a stock's price is high relative to earnings
and possibly overvalued. Conversely, a low P/E
might indicate that the current stock price is low
relative to earnings.

Example of the P/E Ratio

As a historical example, let's calculate the P/E ratio
for Walmart Inc. (WMT) as of Feb. 3, 2021, when the
company's stock price closed at $139.55. [2] The
company's earnings per share for the fiscal year
ending Jan. 31, 2021, was $4.75, according to The
Wall Street Journal. [3]

Therefore, Walmart's P/E ratio was:

$139.55 / $4.75 = 29.38

Comparing Companies Using P/E

As an additional example, we can look at two
financial companies to compare their P/E ratios and
see which is relatively over- or undervalued.

Bank of America Corporation (BAC) closed out the

year 2020 with the following stats:

Stock Price = $30.31

Diluted EPS = $1.87
P/E = 16.21x ($30.31 / $1.87) [4]

In other words, Bank of America traded at roughly

16x trailing earnings. However, the 16.21 P/E
multiple by itself isn't helpful unless you have
something to compare it with, such as the stock's
industry group, a benchmark index, or Bank of
America's historical P/E range.

Bank of America's P/E at 16x was slightly higher than

the S&P 500, which over time trades at about 15x
trailing earnings. To compare Bank of America's P/E
to a peer's, we can calculate the P/E for JPMorgan
Chase & Co. (JPM) as of the end of 2020 as well:

Stock Price = $127.07

Diluted EPS = $8.88
P/E = 14.31x [5]

When you compare Bank of America's P/E of 16x to

JPMorgan's P/E of roughly 14x, Bank of America's
stock does not appear as overvalued as it did when
compared with the average P/E of 15 for the S&P 500.
Bank of America's higher P/E ratio might mean
investors expected higher earnings growth in the
future compared to JPMorgan and the overall
market.

However, no single ratio can tell you all you need to

know about a stock. Before investing, it is wise to
use a variety of financial ratios to determine whether
a stock is fairly valued and whether a company's
financial health justifies its stock valuation.

Investor Expectations
In general, a high P/E suggests that investors are
expecting higher earnings growth in the future
compared to companies with a lower P/E. A low P/E
can indicate either that a company may currently be
undervalued or that the company is doing
exceptionally well relative to its past trends. When a
company has no earnings or is posting losses, in
both cases, the P/E will be expressed as N/A. Though
it is possible to calculate a negative P/E, this is not
the common convention.

The price-to-earnings ratio can also be seen as a

means of standardizing 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 or not a
stock is worth buying.

N/A Meaning
A P/E ratio of N/A means the ratio is not
available or not applicable 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 in the case of an initial
public offering (IPO), but it also means a
company has zero or negative earnings,
Investors can thus interpret seeing N/A as a
company reporting a net loss.

P/E vs. Earnings Yield

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

If Stock A is trading at $10, and its EPS for the past

year was 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)
was $2, it has a P/E of 10 (i.e., $20 / $2) and an
earnings yield of 10% = ($2 / $20).

The earnings yield as an investment valuation metric

is not as widely used as the P/E ratio. Earnings yields
can be useful when concerned about the rate of
return on investment. For equity investors, however,
earning periodic investment income may be
secondary to growing their investments' values over
time. This is why investors may refer to value-based
investment metrics such as the P/E ratio more often
than earnings yield when making stock investments.

The earnings yield is also useful in producing a

metric when a company has zero or negative
earnings. Because such a case is common among
high-tech, high-growth, or startup companies, EPS
will be negative producing an undefined P/E ratio
(denoted as N/A). If a company has negative
earnings, however, it will produce a negative
earnings yield, which can be interpreted and 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
forecasted growth rate. So, to address this limitation,
investors turn to another ratio called the PEG ratio.

A variation on the forward P/E ratio is the

price/earnings-to-growth ratio, or PEG. The PEG ratio
measures the relationship between the
price/earnings ratio and earnings growth to provide
investors with a more complete story than the P/E
can on its own. In other words, the PEG ratio allows
investors to calculate whether a stock's
price is overvalued or undervalued by analyzing
both today's earnings and the expected growth rate
for the company in the future. The PEG ratio is
calculated as a company’s trailing price-to-earnings
(P/E) ratio divided by the growth rate of its earnings
for a specified time period.

The PEG ratio is used to determine a stock's value

based on trailing earnings while also taking the
company's future earnings growth into account and
is considered to provide a more complete picture
than the P/E ratio can. For example, a low P/E ratio
may suggest that a stock is undervalued and
therefore should be bought—but factoring in the
company's growth rate to get its PEG ratio can tell a
different story. PEG ratios can be termed “trailing” if
using historic 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 1 is
typically considered undervalued because its price is
considered low compared to the
company's expected earnings growth. A PEG greater
than 1 might be considered overvalued because it
might indicate the stock price is too high compared
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to the company's expected earnings growth.