P/E RATIO & VALUATION
Plain English
The P/E ratio tells you how much investors are willing to pay for $1 of a company's earnings. A P/E of 20 means investors pay $20 for every $1 of annual profit. Higher P/E = more expensive (or higher growth expected). Lower P/E = cheaper (or lower growth expected).
Going deeper
The Price-to-Earnings (P/E) ratio is the most widely used valuation metric. It's calculated as Stock Price / Earnings Per Share. Trailing P/E uses the last 12 months of actual earnings. Forward P/E uses analyst estimates for next year's earnings. A high P/E might mean the stock is overvalued, or that the market expects high future growth. A low P/E might mean it's undervalued, or the market sees problems ahead. Other valuation metrics include P/S (Price-to-Sales), P/B (Price-to-Book), PEG Ratio (P/E divided by growth rate), and EV/EBITDA. Always compare P/E ratios within the same industry.
Examples
Comparing P/E Ratios
Tech Company A has a P/E of 35. Utility Company B has a P/E of 15. This doesn't mean B is 'cheaper' — tech companies grow faster and typically command higher multiples. Compare A to other tech companies and B to other utilities.
The PEG Ratio
Company X: P/E = 30, Earnings Growth = 30%. PEG = 1.0 (fairly valued). Company Y: P/E = 30, Earnings Growth = 10%. PEG = 3.0 (expensive for its growth rate). The PEG ratio adjusts P/E for growth.