P/E Ratio
The P/E ratio (price-to-earnings) measures how many times a company's annual earnings you are paying when you buy its stock. It is the market's most popular valuation metric — and one of the easiest to misread when used alone.
P/E = Share price / Earnings per share (EPS)If a stock trades at €60 and earns €4 per share, its P/E is 15: you are paying 15 years of current earnings. Read in reverse (1/P/E), a P/E of 15 equals a 6.7% annual earnings yield.
How to interpret it
As a very general reference: below 12 the market is pricing in problems or low growth; between 12 and 20 is reasonable mature-business territory; above 25, the price embeds high growth expectations — which the company will have to deliver.
But the absolute number says little: a P/E of 25 can be cheap for an expanding tech company and a P/E of 8 very expensive for a declining business. The useful comparisons are against the company's own history and its sector peers.
The P/E traps
- Cyclical earnings: a cyclical company at the top of the cycle shows a low P/E right before earnings collapse. The cheap P/E was an optical illusion.
- Unusual years: a one-off (selling a subsidiary, a provision) distorts earnings per share and, with it, the ratio.
- Negative P/E: with losses, the P/E means nothing — other metrics are used.
- It ignores debt: two companies with the same P/E and very different debt loads are not worth the same.
It also pays to distinguish the trailing P/E (last 12 months' earnings, a fact) from the forward one (next year's estimated earnings, an opinion).
P/E and dividends
The connection is direct: the dividend yield equals the payout ratio divided by the P/E. A company with a 60% payout and P/E 15 yields 4%; the same company at P/E 30 would yield 2%. Buying at a reasonable P/E — with a margin of safety — is what locks in a good starting yield for the decades ahead.
Frequently asked questions
What is a good P/E?+
There is no universal number: it depends on the sector, growth and interest rates. The useful question is not "is it low?" but "is it reasonable against its own history and its peers, and why?".
Does a low P/E mean the stock is cheap?+
Not necessarily: it often means the market expects earnings to fall (cyclicals at the peak, declining sectors). An unexplained low P/E is valuation's equivalent of the dividend trap.
What if the P/E is negative?+
The company is losing money and the ratio stops making sense. Those cases are valued with other metrics (sales, cash flow, book value) — and with more caution.