Price-to-Earnings (P/E) Ratio

The price-to-earnings ratio, or P/E, is a stock's share price divided by its earnings per share, and it tells you how many dollars investors are currently paying for each dollar of the company's annual profit.

A $100 stock that earned $5 per share over the last year has a P/E of 20 — investors are paying 20 times last year's profit to own a share. A $100 stock that earned $10 per share has a P/E of 10, half as much for the same price. On its own, neither number says whether the stock is a good buy. It says only what price is currently attached to a dollar of earnings.

What moves the multiple

P/E ratios vary enormously across companies and industries, and most of that variation comes down to growth expectations and risk. A business the market expects to grow earnings quickly, or one seen as unusually stable, tends to trade at a higher multiple than one expected to shrink or one loaded with uncertainty. That's why comparing the P/E of a fast-growing software company to that of a regional bank tells you less about which is the better investment than it seems to — you're comparing two different sets of expectations, not just two prices.

The two common versions

Earnings per share can be trailing (the last twelve reported months, sometimes called trailing P/E) or forward (analysts' estimate of the next twelve months). The two can diverge sharply for a company whose earnings are expected to jump or collapse, so it's worth knowing which version a quoted P/E is using before comparing it to anything else.

• A low P/E can mean genuinely cheap — or it can mean the market expects earnings to fall.
• A high P/E can mean genuinely expensive — or it can mean the market expects earnings to grow into it.
• P/E says nothing about debt, cash flow, or the quality of the earnings themselves.