Price-to-Earnings P E Ratio: Definition, Formula, and Examples

However, including the company’s growth rate to get its PEG ratio might tell a different story. PEG ratios can be termed “trailing” if using historical growth rates or “forward” if using projected growth rates. The P/E ratio also helps investors determine a stock’s market value compared with the company’s earnings. That is, the P/E ratio shows what the market is willing to pay today for a stock based on its past or future earnings. A high P/E ratio could signal that a stock’s price is high relative to earnings and is overvalued.

Trailing P/E Ratio

A P/E ratio, even one calculated using a forward earnings estimate, doesn’t always tell you whether the P/E is appropriate for the company’s expected growth rate. To address this, investors turn to the price/earnings-to-growth ratio, or PEG. While P/E ratios provide important insights into the value of stocks, investors should be cautious about making decisions based on P/E ratios alone.

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Some industries, such as the utilities industry, have historically high P/E ratios. Before investing, it’s wise to use various financial tools to determine whether a stock is fairly valued. The most commonly used P/E ratios are the forward P/E and the trailing P/E. A third and less typical variation uses the sum of the last two actual quarters and the estimates of the following two quarters.

Other important data points to consider along with P/E ratios include dividends, projected future earnings, and the level of debt at a company. The P/E ratio, like other popular valuation metrics, has advantages and limitations. If a company with a high P/E ratio meets the growth expectations implied in its price it can prove to be a good investment. Likewise, a low P/E ratio does not guarantee that a stock is undervalued.

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Trailing 12 months (TTM) represents the company’s performance over the past 12 months. These different versions of EPS form the basis of trailing and forward P/E, respectively. However, no single ratio can tell you all you need to know about a stock. Before investing, it is wise to use a variety of financial ratios to determine whether a stock is fairly valued and whether a company’s financial health justifies its stock valuation. Suppose a publicly-traded company’s latest closing share price is $20.00, and its diluted EPS in the last twelve months (LTM) is $2.00. In this way, some believe that the PEG Ratio is a more accurate measure of value than the P/E ratio.

One way to calculate the P/E ratio is to use a company’s earnings over the past 12 months. This is referred to as the trailing P/E ratio, or trailing twelve month earnings (TTM). Factoring in past earnings has the benefit of using actual, reported data, and this approach is widely used in the evaluation of companies. For example, in February 2024, the Communications Services Select Sector Index had a P/E of 17.60, while it was 29.72 for the Technology Select Sector dividends in arrears Index. To get a general idea of whether a particular P/E ratio is high or low, compare it to the average P/E of others in its sector, then other sectors and the market. While the P/E ratio is a commonly used metric, you can also use several other alternatives.

The price-to-earnings (P/E) ratio is one of the most widely used tools that investors and analysts use to determine a stock’s valuation. The P/E ratio is one indicator of whether a stock is overvalued or undervalued. Also, a company’s P/E ratio can be benchmarked against other stocks in the same industry or the S&P 500 Index. The P/E ratio, often referred to as the “price-earnings ratio”, measures a company’s current stock price relative to its earnings per share (EPS). By including expected earnings growth, the PEG ratio is considered an indicator of a stock’s true value. And like the P/E ratio, a lower PEG Ratio may indicate that a stock is undervalued.

The PEG ratio uses trailing P/E ratio and divides it by a company’s earnings growth over a specified period of time. Forward P/E ratios can be useful for comparing current earnings with future earnings to estimate growth. The last alternative to consider is the enterprise value-to-EBITDA (EV/EBITDA) ratio. It assesses a company’s valuation relative to its earnings before interest, taxes, depreciation, and amortization. The EV/EBITDA ratio is helpful because it accounts for the company’s debt and cash levels, providing a more holistic view of its valuation compared to the P/E ratio.

How to Calculate P/E Ratio

1. In addition, investors should keep in mind that the trailing P/E ratio (the most widely used form) is based on past data and there is no guarantee that earnings will remain the same.
2. Cautious investors don’t always trust the calculations of analysts or the figures published by a company.
3. Our writing and editorial staff are a team of experts holding advanced financial designations and have written for most major financial media publications.
4. For equity investors who earn periodic investment income, this may be a secondary concern.

It doesn’t account for future earnings growth, can be influenced by accounting practices, and may not be comparable across different industries. It also doesn’t consider other financial aspects such as debt levels, cash flow, or the quality of earnings. Because a company’s debt can affect both share price and earnings, leverage can skew P/E ratios as well. The firm with more debt will likely have a lower P/E value than the one with less debt. However, if the business is solid, the one with more debt could have higher earnings because of the risks it has taken.

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A lower P/E ratio is like a lower price tag, making it attractive to investors looking for a bargain. In practice, however, there could be reasons behind a company’s particular P/E ratio. For instance, if a company has a low P/E ratio because its business model is declining, the bargain is an illusion. A main limitation of using P/E ratios is for comparing the P/E ratios of companies from varied sectors. Companies’ valuation and growth rates often vary wildly between industries because of how and when the firms earn their money.

Like any other fundamental metric, the price-to-earnings ratio comes with a few limitations that are important to understand. Companies that aren’t profitable and have no earnings—or negative earnings per share—pose a challenge for calculating P/E. Some say there is a negative P/E, others assign a P/E of 0, while most just say the P/E doesn’t exist (N/A) until a company becomes profitable. The stock price (P) can be found simply by searching a stock’s ticker on a reputable financial website. Although this concrete value reflects what investors currently pay for the stock, the EPS is related to earnings reported at different times. The absolute P/E ratio is the most commonly used form and represents the P/E of a 12-month time period.