Price-to-Earnings Ratio

1.0 The Formula

Basic Form

formulaP/E = Market Price per Share ÷ Earnings per Share (EPS)

Inverse (Earnings Yield):
E/P = EPS ÷ Price = 1 / P/E

The P/E ratio can be read two ways. A P/E of 25 means you pay $25 for every $1 of earnings. The inverse — the earnings yield — is 4%, which can be compared directly to bond yields or savings rates.

Worked Example

Company B generates the most earnings per dollar of share price. Company C requires 50 years of current earnings to "pay back" the price — the market is betting heavily on future growth.

2.0 Trailing vs. Forward P/E

The most common source of confusion. Two analysts can quote different P/E ratios for the same stock on the same day because they're using different earnings numbers.

When They Diverge

exampleNVIDIA (hypothetical snapshot):

  Trailing EPS (TTM):  $2.50
  Forward EPS (est):   $4.80
  Share Price:         $120

  Trailing P/E: 120 / 2.50 = 48.0  ← Looks expensive
  Forward P/E:  120 / 4.80 = 25.0  ← Looks reasonable

Same stock. Same price. Two different stories.
The gap tells you: analysts expect earnings to nearly double.

3.0 Sector Benchmarks

P/E ratios vary dramatically by sector because industries have structurally different growth rates, capital intensity, and risk profiles. Comparing a tech stock's P/E to a utility's P/E is meaningless.

Historical S&P 500 P/E

referenceLong-term average (1950–2025):  ~17–18x trailing
Post-2010 average:               ~21–23x trailing
Dot-com peak (2000):             ~30x trailing
GFC trough (2009):               ~10x trailing (earnings collapsed)
Current range (2024–2026):       ~20–25x forward

The "market is expensive" or "cheap" is always relative
to the interest rate environment. Higher rates compress
P/E multiples. Lower rates expand them.

4.0 Earnings Quality

The E in P/E is not always what it seems. Earnings can be inflated, distorted, or manufactured. The ratio is only useful when the earnings number is real.

Red Flags

• Non-recurring items. A company sells a building and books a one-time gain. EPS spikes, P/E drops, but the business didn't actually become more profitable. Always check for "adjusted" vs. GAAP earnings.
• Share buybacks. EPS rises because the denominator (share count) shrinks, not because total profit grew. Revenue flat + EPS up = buyback-driven growth. Check total net income, not just EPS.
• Aggressive accounting. Revenue recognition timing, capitalized expenses, pension assumptions — all can inflate reported earnings. If EPS growth consistently outpaces revenue growth, investigate.
• Cyclical peaks. A mining company at peak commodity prices shows massive EPS and a low P/E. The market "knows" earnings will revert. A low P/E at a cycle peak is a trap, not a bargain.

GAAP vs. Non-GAAP

exampleCompany X reports:

  GAAP EPS:      $2.10  (includes $0.80 restructuring charge)
  Non-GAAP EPS:  $2.90  (excludes restructuring)
  Price:         $72.50

  P/E (GAAP):      34.5
  P/E (Non-GAAP):  25.0

Which is "real"? Depends on whether the restructuring is
truly one-time. If the company takes a "one-time" charge
every year, GAAP is the honest number.

Negative Earnings

If EPS is negative, P/E is undefined (or negative, which is meaningless). For loss-making companies, use alternative metrics:

• Price-to-Sales (P/S) — revenue-based, works for pre-profit companies.
• EV/Revenue — enterprise value to revenue, accounts for debt.
• Price-to-Book (P/B) — asset-based, useful for financials and asset-heavy industries.

5.0 P/E in Practice

Screening Filter

pseudocodeScreen for value:
  1. Filter: Trailing P/E between 8 and 20
  2. Filter: Earnings growth > 0% (not declining)
  3. Filter: Market cap > $10B
  4. Sort: P/E ascending

Screen for growth at reasonable price (GARP):
  1. Filter: Forward P/E < 25
  2. Filter: EPS growth > 15%
  3. Calculate: PEG = Forward P/E / Growth Rate
  4. Filter: PEG < 1.5
  5. Sort: PEG ascending

The Earnings Yield Framework

Instead of thinking in P/E multiples, flip it to earnings yield and compare against alternatives:

If a risk-free bond yields 5% and a stock earns 4.2%, the stock needs to grow earnings to justify the risk. That growth expectation is exactly what the PEG ratio quantifies.

What P/E Cannot Tell You

• Whether earnings will grow, shrink, or stay flat.
• How the company is financed (debt vs. equity) — use EV/EBITDA for that.
• Whether the business generates actual cash — use FCF yield for that.
• Whether the growth premium is justified — use PEG ratio for that.

6.0 Related Pages