Understanding the P/E Ratio: A Fundamental Metric
The Price-to-Earnings ratio is the most popular valuation metric. Here is how to use it correctly.
By Gajji Srinath4 min read
The Price-to-Earnings (P/E) ratio is a key metric used by investors to determine if a stock is overvalued or undervalued.
What is P/E Ratio?
It is the ratio of a company's share price to its earnings per share (EPS).
Formula: P/E = Market Value per Share / Earnings per Share (EPS)
Interpreting the P/E Ratio
- High P/E: Investors expect higher earnings growth in the future compared to companies with a lower P/E. It could also mean the stock is overvalued.
- Low P/E: The company may be undervalued, or investors are expecting earnings to fall.
Types of P/E
- Trailing P/E: Based on the last 12 months of earnings.
- Forward P/E: Based on estimated future earnings.
The P/E ratio is best used when comparing companies within the same industry.