What it means
P/E stands for price to earnings. The numerator is the current share price, and the denominator is the earnings per share, which is profit after tax divided by the number of shares.
The trailing version uses the sum of the last four quarters of reported earnings. A higher figure means investors are willing to pay more for each dollar of profit.
That might reflect expected growth, low risk or enthusiasm, while a lower figure might reflect slow growth, higher risk or pessimism. The ratio has no single correct level, and it varies widely by industry and market conditions.
Its main strength is that it uses facts. The earnings have been reported and audited, so the ratio does not rely on forecasts, which can be optimistic.
Its main weakness is that it looks backwards, so it may not reflect a company whose profits are about to rise or fall sharply. The ratio is distorted when earnings are unusually high or low.
A one-off gain can make the P/E look low, and a temporary loss can make it very high or meaningless, since a negative P/E is not generally quoted. Many analysts adjust earnings for unusual items before calculating the figure.
It is best compared with similar companies and with the company's own history. Comparing a bank with a software firm using trailing P/E can mislead because their growth and capital needs are different.
The forward P/E, which uses forecast earnings, is the usual companion measure. Finance teams use the ratio when valuing a business, assessing an acquisition or explaining a share price to a board.
It gives a quick sense of what the market expects, but it should be combined with cash flow, debt and growth analysis.
In practice
Real-world examples.
Example
A fund analyst compares two supermarket groups. One has a trailing P/E of 14 and the other of 18, and she asks why the market pays more for the second. She finds it has faster growth and a stronger balance sheet.
Example
A founder preparing to sell a company in the same sector as a listed rival checks the rival's trailing P/E of 22. She uses it as a rough guide to the multiple of profit that buyers might pay. She knows private companies usually trade at a discount.
Example
A board member reads that the company's trailing P/E has jumped from 15 to 40. The finance director explains that profit fell because of a one-off restructuring charge, not that the share price doubled. The board asks for an adjusted figure.
Formula
Calculation
Trailing P/E = share price / earnings per share over the last twelve months
Suppose a company's shares trade at $60 and its earnings per share in the last four quarters were $0.70, $0.75, $0.80 and $0.75. Trailing EPS = 0.70 + 0.75 + 0.80 + 0.75 = $3.00. Trailing P/E = 60 / 3.00 = 20. Investors are paying $20 for each $1 of profit earned over the last year, and the earnings yield, the inverse, is 3.00 / 60 = 5%.Case study
Seen in the real world.
Elmstead Components is a fictional manufacturer used to illustrate the ratio. Its shares traded at $45 and its trailing earnings per share were $5.00, giving a trailing P/E of 9. An investor thought the share looked cheap compared with peers at 15.
A closer look showed that the trailing earnings included a one-off $2.00 per share gain from selling a property. In this illustrative case, adjusted earnings were $3.00 and the adjusted trailing P/E was 15, in line with peers. The lesson is that the ratio is only as good as the earnings behind it.
The investor wrote a short note for her team explaining the adjustment and listed the two questions she would ask before relying on any P/E in future. The first was whether earnings included one-off items, and the second was whether the peers were truly comparable.
Watch out
Common mistakes.
- Treating a low P/E as automatically cheap. The market may be pricing in falling profits or high risk.
- Comparing across industries. Growth rates, capital needs and risk differ widely, so peers are a fairer benchmark.
- Ignoring one-off items in earnings. They can make the ratio misleadingly low or high.
Questions
People also ask.
What is the difference between trailing and forward P/E?
Trailing uses the last twelve months of actual earnings, while forward uses analysts' forecasts for the next twelve months.
Can P/E be negative?
If earnings are negative the ratio is usually reported as not meaningful or not applicable.
What is a good P/E?
There is no universal answer, because it depends on growth, risk, interest rates and the sector, so compare with peers and history. A figure that is far from both deserves an explanation before it is acted on.
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