P/E Ratio (Price-to-Earnings)

If a share costs $100 and the company earned $5 per share last year, the P/E is 20. Read literally, that says you are paying twenty dollars for each dollar of annual earnings, or that at last year's rate of profit it would take twenty years of earnings to equal the price.

The ratio is mostly a statement about expectations. A high P/E means the market is paying a lot relative to current earnings, which usually reflects an expectation that earnings will grow into the price. A low P/E means it is paying less, which can reflect an expectation that earnings will fall, or slower growth, or something specific to that company. The ratio itself does not distinguish between those explanations, and this is the single most common place beginners are led astray: the number tells you what is being paid, not whether it is a good idea.

Normal ranges differ sharply between industries, so a P/E is only informative next to something comparable: the same company's own history, or other companies doing the same thing. Comparing a software company's P/E with a utility's compares two industries, not two investments.

Trailing P/E uses the last twelve months of reported earnings, which are real but backward-looking. Forward P/E uses analyst estimates for the next twelve months, which look ahead but are forecasts. A company that lost money has no meaningful P/E at all, because there is no profit to divide by, which is why company pages show N/A rather than a number.