P/E Ratio: How to Compare It and Why Low Isn't Always Cheap
The P/E ratio, or price-to-earnings ratio, shows how many dollars investors pay for each $1 of a company's yearly profit. You find it by dividing the share price (what one share costs) by earnings per share, or EPS, which is the company's profit for the last 12 months split across its shares. That lets you compare companies of very different sizes. P/E describes price against profit; it is not a grade for the company or a forecast for its stock.
What It Means
A share price on its own is hard to judge. A $200 share and a $20 share say nothing about which company earns more, because each company has a different number of shares. Dividing by profit per share fixes that.
P/E is also a look backward. It uses the profit of the last 12 months, not a forecast. The ratio is price divided by profit, so a new price gives a new P/E even when the profit stays the same, and new profit does the same when the price stays put.
How It's Calculated
In plain words, divide the share price by EPS. In the made-up example below, Company A trades at $54 and earned $3 per share, so its P/E is 18: investors pay $18 for each $1 of yearly profit. The table then changes one number at a time. All figures are made up.
| Made-up case | Share price | EPS, last 12 months | P/E |
|---|---|---|---|
| Starting point | $54 | $3 | 18 |
| Price rises | $63 | $3 | 21 |
| Price falls | $48 | $3 | 16 |
| Profit rises | $54 | $4.50 | 12 |
The last row is the one to study. The price did not move, yet the P/E dropped from 18 to 12 because the profit grew.
How to Read It
Three readings turn the number into a question worth asking.
- Compare within a sector. Typical P/E levels differ by industry, so compare a company with others in the same kind of business. In Rapunzl's Stock Scanner, Sector is a field you can combine with P/E for this.
- Compare with the company's own history. A P/E of 18 reads differently if the same company stood at 25 a year earlier (a made-up case). The drop could come from either number, so check which.
- Read a missing P/E as a message. A company that lost money has no meaningful P/E, and the Stock Scanner lists none for it. The blank is not an error: there is no profit to divide by.
Where It Misleads
A low P/E is not automatically cheap. If the market thinks a company's profit is about to shrink, people will pay less for each share today, and that pulls the price, and so the P/E, down. A P/E can also look low only because profit jumped once, say from a one-time gain, so the same price divided by a normal profit would give a higher number.
A high P/E is not automatically a problem either. It often reflects growth that investors expect, because they are paying today for profit they think will be larger. Because P/E looks back at the last 12 months, it cannot see that growth. P/E is one question about a company, so pair it with others before drawing any conclusion.
Try It in Rapunzl
P/E is a company number, so you can screen for it. In the Stock Scanner, open the Value category, which asks how much you pay compared with what the company earns or owns, and choose Price-to-earnings (P/E). You can set the conditions At most, At least or Between. The same category holds other value ratios.
To compare like with like, add Sector from the Size & sector category. The Stock Scanner filters guide covers ready-made ideas and starting ranges.
A 15-Minute Class Activity
Match the P/E. Students work in pairs with a calculator and the six made-up companies below. The two sectors are invented for this exercise and imply nothing about real sectors.
| Company (made-up) | Sector | Share price | EPS, last 12 months |
|---|---|---|---|
| A | Sneaker brands | $36 | $3 |
| B | Sneaker brands | $52 | $4 |
| C | Sneaker brands | $78 | $3 |
| D | Software firms | $120 | $4 |
| E | Software firms | $90 | $3 |
| F | Software firms | $50 | -$2 (a loss) |
- 3 minutes. Write the formula on the board and work Company A together. Write these answers in a jumbled list on the board: 12, 13, 26, 30, 30, no P/E.
- 5 minutes. Pairs calculate each P/E and match every company to an answer on the board. The matches are A 12, B 13, C 26, D 30, E 30 and F no P/E, because F lost money.
- 4 minutes. Pairs sort the companies by sector and find the one that stands out within its sector. It is Company C. Then they compare C with Company D: C's 26 is lower than D's 30 across the two sectors, but it is the highest in its own.
- 3 minutes. Exit ticket: each student writes one sentence on how a P/E of 26 can be high for one company yet ordinary for another.
Related Indicators
- How to Calculate EPS: the profit per share that P/E divides into the price.
- Market Cap: the other company number that sorts firms by size, not by price against profit.
- Technical Analysis: the chart-reading side, in contrast with company numbers like P/E.
Frequently Asked
Questions
P/E stands for price-to-earnings. It is the share price divided by the earnings per share over the last 12 months.
The Stock Scanner does not show a negative P/E. A company with a loss has no meaningful P/E, so it lists none, because the ratio needs a profit to divide by.
Not by itself. A high P/E often reflects expected growth, so it tells you what investors are paying for each $1 of profit, not whether the company is doing well.
The P/E is price divided by profit, so a different price gives a different ratio even when profit is unchanged. Profit per share changes only when the company reports new results.
Teach Company Numbers With Rapunzl
Economics and business teachers can request a demo and try the Stock Scanner, charts and simulator against their own course plan. A parent who wants a student to explore this at home can begin on our parents page.
Indicators, patterns and examples in this article are for education and are not investment advice or a recommendation to buy or sell any security.
By Myles Gage, CEO & Co-Founder at Rapunzl.