P/E Ratio

Price-to-Earnings ratio — a stock's price divided by its earnings per share, the most widely used valuation metric in equity analysis.

The P/E ratio answers the question: how much are investors paying for each dollar of earnings? A P/E of 20 means investors are paying $20 for every $1 of annual earnings. The "trailing P/E" uses the last 12 months of actual earnings; the "forward P/E" uses analyst estimates for the next 12 months. High P/E stocks are often growth-oriented — investors are paying up for expected future earnings growth. Low P/E stocks are often value plays, mature businesses, or companies under distress.

The P/E ratio varies enormously across sectors, market cycles, and interest rate environments. Technology companies often trade at P/Es of 30–60× because of high expected growth; utilities and financials trade at 10–15× because of more predictable, slower growth. During low interest rate periods, P/Es tend to expand because the opportunity cost of holding equities (vs. bonds) declines. Rising rates cause P/E compression as investors discount future earnings more heavily.

The Shiller CAPE (Cyclically Adjusted P/E) uses 10 years of inflation-adjusted earnings to smooth out business cycle swings and give a longer-term valuation perspective. When the CAPE is at historically high levels it has been associated with lower subsequent 10-year returns, though it is a poor short-term timing tool.

This definition is for informational and educational purposes only. Nothing on Finance Compass constitutes financial, investment, or trading advice. Always conduct your own research and consult a qualified professional before making financial decisions.