What is the P/E ratio? Price-to-earnings explained with examples

The P/E ratio is the most widely quoted valuation multiple. It answers the question: how much are investors paying today for one unit of the company's annual profit? A P/E of 20 means the market values the company at 20 times its yearly earnings. Put another way, if profits stayed flat and were all paid out, it would take 20 years to 'earn back' the price.

The inverse of P/E is the earnings yield (E/P). A P/E of 20 is an earnings yield of 5%, which makes it easy to compare a stock with, say, a bond yield.

There are two equivalent ways to compute it, plus two close relatives:

P/E            = share price ÷ earnings per share (EPS)
P/E            = market cap ÷ net profit
Earnings yield = EPS ÷ price = 1 ÷ P/E
PEG            = P/E ÷ annual EPS growth (in %)

Trailing P/E (often labelled TTM) uses the last twelve months of reported earnings. Forward P/E uses analysts' estimates for the next year, so it is only as good as those estimates. Our stock pages show both, plus the PEG ratio, which divides P/E by the expected growth rate to account for how fast profits are rising.

A share costs $60 and the company earned $3 per share over the past year: P/E = 60 ÷ 3 = 20, an earnings yield of 5%. If analysts expect EPS of $4 next year, the forward P/E is 60 ÷ 4 = 15. And if earnings are growing 20% a year, PEG = 20 ÷ 20 = 1.0 — a level many investors, following Peter Lynch, treat as roughly fair for a growth stock.

Context is everything. Fast-growing software companies routinely trade at P/Es above 30, while banks and utilities often sit near or below 10. A low P/E can signal a bargain, but it can also signal that the market expects profits to fall. Compare a company with its own history and its closest peers, not with the whole market.

P/E is meaningless when earnings are negative or close to zero, and one-off gains or write-offs can distort it badly. Cyclical companies are a classic trap: their P/E looks lowest at the top of the cycle, when profits peak, and highest at the bottom.

Earnings are an accounting figure and can differ from cash flow. P/E also ignores debt — two companies with the same P/E can carry very different risks — so look at enterprise-value multiples and the balance sheet too. For whole markets, some analysts prefer the cyclically adjusted P/E (CAPE or Shiller P/E), which averages ten years of inflation-adjusted earnings.