P/E ratio
Price divided by earnings per share: how many years of profit the market pays for.
How many years of earnings
The P/E divides a share price by earnings per share. A P/E of 20 means the market pays 20 times annual earnings: it would take 20 years of flat earnings to “pay back” the price. It can be trailing (past earnings) or forward (expected earnings over twelve months).
Why P/Es do not all compare
A fast-growing company deserves a higher P/E because its future earnings will be larger. Cyclical sectors (banks, autos) often trade on low P/Es, technology on high ones. Rates matter too: when rates rise, P/Es tend to fall. A stock is therefore compared with its sector and its own history.
- Earnings yield = 1 / P/E
Two companies at the same price
- A and B trade at €100. A earns €8 a share, B €4.
- P/E of A: 100 / 8 = 12.5. P/E of B: 100 / 4 = 25.
- If B doubles its earnings in 3 years while A stalls, B falls back to a P/E of 12.5 at the same price.
A high P/E is not necessarily expensive: it pays for expected growth.
Common mistakes
- Comparing P/Es across sectors.
- Trusting a low P/E built on a one-off gain: it will not last.
- Computing a P/E on a loss: it means nothing.
Notitia newsroom · education, not investment advice.