Price to Earnings Ratio (PE Ratio): Formula, Calculator, & Importance

What is the Price-to-Earnings Ratio (P/E ratio or PE ratio)?

PE ratio is a metric valuing a company relative to its earnings-per-share. It measures how pricey a stock is compared to its earnings.

This guide will help you understand every aspect of P/E Ratio and use it to your advantage. You'll also find some analogies from a few legends, so you have a cool way to explain to your buddies at the bar. Celebrity quotes and images are not real, for entertainment purposes only.

You'll notice three variations of this term in the article. They're all the same thing. PE Ratio = P/E Ratio = Price-to-Earnings Ratio.

We'll also compare it to closely related financial ratios like PEG ratio and P/S ratio.

How Investors Use PE Ratio

Investors may use the forward or trailing PE ratio to evaluate a company. They may use it to compare:

• Current PE ratio to past PE ratio for the company
• PE ratio for a company versus one of its competitors
• Company PE ratio to sector PE ratio or industry PE ratio
• One sector or industry PE ratio to that of another.

PE Ratio Calculator

The PE Ratio Calculator works by dividing the current stock price by the company's earnings-per-share (EPS).

The PE ratio calculator calculates a company's price-to-earnings ratio using the stock price and the earnings-per-share figure. No symbols like $ or commas should be used in the PE ratio calculator.  

You can also make this calculation by hand using the PE Ratio formula below. Remember that companies with negative earnings don't have a PE ratio.

P/E Ratio Formula

Use the P/E ratio formula below to calculate it by hand or using a regular calculator.

P/E Ratio = ( Market Value Per Share / Earnings-Per-Share )

To calculate price-to-earnings ratio for any stock:

1. Find the most recent stock price, per share.
2. Find the most recent earnings release.
3. Divide price by earnings per share.
   1. Use the TTM (trailing twelve months) earnings number to calculate trailing P/E ratio
   2. Use the earnings guidance number to calculate forward P/E ratio

The trailing P/E ratio gives you their valuation of price relative to past earnings. It's a valuation based on what the company has already reported.

The forward P/E ratio gives you stock valuation based on future earnings. It uses the company's best estimate of what they'll earn in the future.

You can find current stock prices and EPS on any site that provides market quotes.

Understanding the P/E Ratio

People may also refer to P/E ratio as the earnings multiple or price multiple. P/E ratio indicates how much investors may pay for each dollar of the company's reported earnings.

The Price-to-earnings ratio allows investors to quickly assess a stock's relative valuation. Relative valuation compares two companies.

Comparing the stock prices alone of two companies would be like comparing apples to oranges. The EPS denominator in P/E ratio makes it more of an "apples to apples" comparison.

"Explain P/E Ratio to Me Like I'm Five"

The P/E ratio is like a score for a company. P/E stands for price-to-earnings. The ratio helps people compare different companies.

It tells you how much people are willing to pay for a company's stock, compared to how much money the company earns. A higher P/E ratio means people are willing to pay more for a company's stock. This means they think the company will earn more money in the future. 

Why is PE Ratio Important?

The PE ratio is important as a key indicator of a company's financial health. In a simple way, it tells us how much investors are willing to pay for each dollar of a company's earnings. 

This simple metric provides investors with a measurable way to make comparisons between:

• Past and present
• Competing companies
• A company and its industry or sector

Using the price-to-earnings ratio, investors can make these comparisons by a common metric. Making comparisons side-by-side based on P/E can help them:

• identify companies to invest in.
• choose between two different companies.
• choose what price they want to pay for a company.
• avoid investments that may be unfavorable.

These factors make PE Ratio an important tool for investors and analysts.

P/E Ratio Example

Tesla P/E ratio makes a great P/E ratio example, because analysts have hotly debated TSLA's valuation throughout the company's history.

Tesla P/E Ratio Chart

As you can see, when they were posting losses every quarter, there was no way to calculate a P/E ratio. When they became profitable, their P/E ratio was immediately sky-high, at 512. That was because earnings were still small but the stock price was already $72/share.

As investor expectations for Tesla's future earnings rose, the share price rose, and P/E ratio topped out at over 1100. 

But then, earnings began to rise, reducing the P/E ratio even as Tesla's stock price continued to rise. 

Now, in Q1 2023, Tesla's stock price has fallen significantly, while earnings have yet to decrease. This leaves TSLA with a relatively low P/E in comparison to prior periods.

To use this data, you might compare the current P/E ratio of Tesla (37.82) to the ratio from Q1 2022 (146.22).

37.82 vs 146.22... That's quite a bit cheaper! If you were an investor looking to hold TSLA long term, you might see this as an opportunity. If you expected earnings to rise, or if you expected investor sentiment to improve on TSLA, you might see this as your time to buy.

You could draw these conclusions:

• Investors (on average) still expect TSLA earnings to rise, since 37.8 is still not a "low" P/E ratio. 
• Investors' earnings expectations for TSLA aren't as optimistic now as they once were.
• Investors may expect slower growth from TSLA in the coming months and years

You might also compare the TSLA P/E ratio to that of another auto company, like GM

Whether GM and TSLA are similar enough to compare is also a point of debate. But, there aren't many profitable US companies producing electric vehicles. So, this is probably still the closest option.

As you can see, TSLA PE is still significantly higher than GM's, even at its new lower level (37.8 vs 6.2 for GM). That's over 500% higher.

In fact, GM P/E ratio has only been as high as Tesla's current figure once in the last four years - and that was when GM was just coming back from losing money.

You could draw a few conclusions in comparison:

• Investors don't speculate as much on the future earnings of GM
• Investors expect slower growth (if any growth) out of GM than out of TSLA
• Investors might be holding GM shares for reasons other than growth (dividends, stock buybacks, etc.)

Trailing PE Ratio vs Forward PE Ratio

The main difference between trailing PE ratio and Forward PE ratio is the earnings period used for price-to-earnings ratio calculations.

Trailing PE ratio uses the last twelve months of reported earnings-per-share. This is usually called TTM (trailing twelve months).

Forward PE ratio uses the company's projected earnings-per-share (EPS) for the next quarterly report.

You can compare future P/E to trailing P/E to get a picture of what analysts expect for the future of a company. If forward P/E is lower than trailing, analysts are expecting earnings to grow in the next quarter. If trailing P/E is higher than forward, they may be expecting earnings to decline.

Whether you use that information to make an investment is up to you. But you should invest with the future in mind.

Trailing Price-to-Earnings Ratio

Since trailing price-to-earnings uses real historical financial figures, analysts consider it more reliable. This assumes, of course, the company reported earnings accurately. Some investors and analysts don't trust future earnings projections. Those who feel that way may rather rely on reported earnings data.

However, investors must focus on the future. They should invest their money based on future earnings power and future growth. Past results don't predict future results, and investors shouldn't expect them to. Investors who build expectations from trailing price-to-earnings may be in for a surprise.

Forward Price-to-Earnings Ratio

Forward price-to-earnings ratios tell you how much investors are willing to pay per share of a company's future earnings. Forward price-to-earnings uses the projected EPS for the next quarterly report, which is usually given with the current quarterly report.

Forward price-to-earnings ratios can be more helpful in determining what analysts expect for the future growth of the company.

If analysts expect earnings to rise next quarter, that increases the denominator in the forward P/E ratio calculation. So at the current price, that would create a lower forward P/E ratio.

If analysts expect earnings to fall next quarter, that could lower the denominator of the forward P/E calculation. With price the same, that would increase the forward P/E ratio.

What are the Limitations of P/E Ratio?

You should know the limitations of P/E ratio before relying on it for your analysis. It is just one metric, and only includes two variables. And, one of those variables (earnings) doesn't always paint a clear picture.

P/E Ratio is limited in that it:

• doesn't consider company debt or liabilities.
• doesn't factor in where a company is in its lifecycle.
• doesn't factor earnings growth rate
• can be affected by stock buybacks which artificially raise earnings-per-share - thus lowering P/E.
• can't be used for companies that aren't yet profitable, or that are going through a period of unprofitable growth.

Because P/E relies on earnings-per-share, differences in accounting policies can affect it. Accounting policies may differ between companies, or between different periods for one company. Earnings-per-share can be affected by these differences, which alters P/E ratio.

Earnings-per-share can also be affected by:

• interest, taxes, depreciation, and amortization (see EBITDA)
• large one-time expenses
• anything that affects shares outstanding: stock issuance, employee stock options, conversion of other assets into stock, and buybacks.

Additional limitations that apply to most valuation metrics also apply to P/E:

• Past results aren't predictive of future results (trailing price-to-earnings)
• Future projections (forward price-to-earnings) by companies contain inaccuracies and biases. Countless unknown variables could alter the expected outcome.

Alternatives to P/E Ratio

There are several other ratios investors and analysts may use to value a stock. These alternatives to P/E ratio include earnings yield, PEG ratio, relative P/E, and price-to-sales ratio (P/S or PSR).

From all of these, I prefer the PEG ratio and price-to-sales ratio. You'll see why below.

P/E vs PEG ratio

The PEG ratio is the price/earnings-to-growth ratio. It can be compared to forward P/E, since it's used to get a better picture of a company's projected growth rate.

PEG compares the P/E ratio to earnings growth to provide this better picture. Investors use the PEG to determine whether a stock price is over or undervalued. They use it because it directly compares trailing P/E to the growth rate of earnings from a specified period.

PEG can be either "trailing" or "forward. Trailing PEG uses past (observed) growth rates, while forward PEG uses future (projected) growth rates.

PEG ratio can shed light on stocks with low P/E. Just looking at P/E, you'd say they're undervalued. But those same stocks may be overvalued based on their earnings growth. 

As a rule of thumb, "bargain" companies would have a PEG ratio under 1, while "pricey" companies' PEG ratios would be over 1.

Consider an example:

1. Company A with P/E ratio of 40, growing at 30% yearly

2. Company B with P/E ratio of 60, growing at 70% yearly

PEG ratios are as follows:

• Company A: (40 / 30) = 1.33
• Company B: (60 / 70) = 0.86

So, while company B looks more expensive by P/E, we can see that per dollar of earnings growth, it's actually cheaper than company A. Investors looking for a discount on earnings growth may choose to buy company B.

In this way, PEG ratio tells you what you would be paying for each dollar of earnings growth.

P/E Ratio vs Earnings Yield

Earnings yield, or E/P ratio, is simply the inverse of P/E ratio.

The fraction is flipped to show the earnings as a percentage of stock price. This is then used to represent the "ROI" of a stock, but I don't think it's an effective measure. It's not commonly used, so I suppose others feel the same.

The only noticeable benefit of E/P ratio is that negative earnings yields can be compared to one another. Where negative P/E ratios can't be used, some investors might find this helpful for comparing companies with negative earnings. I prefer to use another metric, like P/S, for such companies.

Some investors might consider using earnings yield to factor investment income. But, they'd find more accuracy by looking at dividend amounts and dividend histories for that.

Relative P/E vs Absolute P/E

Relative P/E differs from absolute P/E by comparing P/E across more than one time period. 

If you recall, both trailing P/E and forward P/E use today's stock price to calculate the ratio, based on either past or projected earnings.

Relative P/E takes today's absolute P/E and compares it to past P/E. Past P/E ratio used for comparison may come from a benchmark year or a range of years.

Investors may use relative P/E to compare current P/E to P/E during the lows of the great financial crisis, or the highs of the recent bull market.

Regardless of what range is used for comparison, relative P/E usually uses the highest P/E during that time range. That's the default.

But some investors may choose to compare current P/E to the low value of the range. That might come in handy if looking for more evidence that you're buying at a relatively cheap price in a bear market, for example.

Once again, relative P/E is based on percentage. If past P/E is higher than current, relative P/E will be less than 100%, or less than 1. If past P/E is lower, relative P/E will be over 100%, or more than 1.

P/E Ratio vs Price-to-Sales Ratio

The debate between P/E Ratio vs price-to-sales ratio (P/S) comes down to simplicity. Although it sounds like they have an equal number of variables (stock price, eps) vs (stock price, sales), that's not the case.

Price-to-sales ratio uses the market cap (capitalization) of a company, divided by sales, to determine valuation.

P/S ratio = (Company Market Cap) / (Annual Company Sales)

Usually, the P/S ratio formula uses the revenue for the last 12 months, also known as  TTM (trailing twelve months). Some analysts may also calculate a forward P/S, using the next 12 months' projected revenue instead. You can run this calculation on paper, a calculator, or use the price-to-sales ratio calculator    

Why is P/S more simple than P/E?

Price-to-sales doesn't rely on the often-complex accounting practices used to calculate earnings. 

When you compare two companies' P/E ratios, you rely on their EPS figure. Each company's EPS may be calculated differently. So you could be inadvertently just comparing their accounting practices.

Using price-to sales ratio, you strip away all the accounting noise. In an era where mathematical gymnastics are a regular part of corporate accounting, I believe this is helpful.

You also eliminate variables such as:

• The effects of issuing or buying back shares, or converting other securities to stock 
• Interest, taxes, depreciation, and amortization (see EBITDA)
• Large one-time expenses
• Profitability

Now, you may say, hold on...why would you want to remove profitability from the equation?

If you only consider companies that already profitable, you overlook a large swath of potential investments. Companies that aren't profitable yet might still be good investments. Here are some types:

• Early-stage growth companies
• Pharmaceutical companies
• Companies going through periods of heavy investment (for future growth)
• Companies that made large accounting adjustments in the prior year

Price-to sales ratio helps you compare all these companies against each other. You can look at their potential for profitability individually. You can compare them to profitable companies.

And, for companies that don't turn a profit, you won't be stuck at no P/E, or "P/E ratio N/A".

Meaning of "P/E Ratio N/A"

"P/E ratio N/A means a stock doesn't have a P/E ratio. This happens when a company's earnings are negative or nonexistent.

Since P/E is calculated by dividing stock price by EPS (earnings-per-share), if a company doesn't have earnings, it can't be calculated. Any number divided by zero is zero.

When a company loses money and reports negative EPS, that also throws off the equation. Sure, you could calculate a negative P/E in this case. But that wouldn't help you. You couldn't gain insight by comparing it to positive P/E ratios.

What is a Good Price-to-Earnings Ratio?

Determining what is a good price-to-earnings ratio requires looking at the industry in which it operates. Some industries have higher average P/E ratios than others. For example, as of January 2023, semiconductor P/E ratios average 70.39 while the apparel sector is averaging 9.47. 

To see where a company stands, compare its P/E ratio to that of its of its industry peers. You can do that using an average as above, or you can compare it to the companies whose businesses are most similar.

As discussed above, though, "good" or "bad" may be a bit subjective. I recommend using the additional ratios mentioned to determine why P/E is low or high. Then use all of your information to make your investment decision.

Do You Want a High or Low P/E Ratio?

Whether you want a high or low P/E ratio depends on your investment goals. Low P/E ratios need context to be fully understood, and so do high P/E ratios.

A low P/E ratio can mean a company is undervalued. It can also mean the market is pessimistic about a company's future earnings.

Companies with high P/E ratios may be overvalued. Or, the market could expect an increase in future earnings and even a large earnings shock to the upside.

Blue-chip companies will often have a lower P/E ratio than average. They've entered a phase where they aren't growing quickly, so investors aren't willing to pay up.

Early-stage growth companies often sport sky-high P/E ratios (if they're even earning money yet). So you may find companies with little or no earnings that are pricey because of expected growth.

For this reason, when determining what a high or low P/E means, I recommend looking at PEG and P/S as well.

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