It is the share price divided by earnings per share — roughly, how many years of current earnings you are paying for. It is useful for comparison, but a low P/E often reflects expected decline rather than a bargain.
Divide the share price by earnings per share. A stock at $50 earning $2 a share has a P/E of 25 — you are paying twenty-five times one year of current earnings.
Because both figures are per-share, the ratio is unaffected by share count. This is what makes it comparable between companies of very different sizes.
A trailing P/E uses the last twelve months of actual earnings. A forward P/E uses estimated future earnings, which are opinions rather than facts.
Forward P/Es are usually lower simply because growth is assumed. Comparing one company's forward P/E to another's trailing P/E compares two different things.
A low ratio often means the market expects earnings to fall, so the denominator is about to shrink. Cyclical businesses look cheapest at the top of their cycle, when earnings are at their peak.
The opposite also holds: a high P/E can reflect confident expectations of growth rather than an overvaluation.
It ignores debt entirely. Two companies with the same P/E can carry very different borrowings, and the more indebted one is the riskier holding.
It also breaks down for companies with no profits, where there is nothing to divide by — which is why loss-making companies are usually compared on revenue instead.
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From StockMotive — the honest why behind every market move. Educational information only, not investment advice.