---
title: "What is the P/E Ratio?"
description: "What is the P/E ratio? How to measure the value of a stock with the stock price to earnings ratio."
canonical_url: https://trendshare.org/how-to-invest/what-is-the-pe-ratio
markdown_url: https://trendshare.org/ai/what-is-the-pe-ratio.md
published: 2013-11-09
last_updated: 2017-08-28
content_license: https://trendshare.org/about/disclaimer
---
# What is the P/E Ratio?

Source: https://trendshare.org/how-to-invest/what-is-the-pe-ratio
Updated: 2017-08-28
Investors love their numbers, and not just the prices of their stocks. Any
serious investor needs to be comfortable with basic arithmetic, a few ratios,
and a little bit of statistics. Some stockpickers take their numbers very
seriously, measuring everything from the volume of shares traded to moving
averages of prices and more, but all you really need is the right information
to give you an edge in the market.

Trendshare tracks several figures from of [quarterly and annual financial statements provided to the SEC](http://www.sec.gov/edgar.shtml), but it all comes down to the simplicity of earnings:
[companies that consistently earn real money are worth owning](https://trendshare.org/how-to-invest/earnings-matter-most). This provides tangible measurements that are easy to
understand and to correlate with the real-world performance of the companies
themselves.

One such measurement is the *P/E ratio*, also known as the *price
earning ratio* or sometimes the *PE ratio*.

## What is the P/E Ratio

The P/E ratio is the current price of the stock—what it costs to buy
one share right now—divided by the yearly earnings of the company per
share. It's the amount of earnings you're entitled to for each share of the
company you own.

Consider an example. If a company earned a million dollars in 2014 and if
there are a million shares of the stock available, the company has earned a
dollar per share. If you can buy a share of the company (let's call it Canada's
Best Lemonade) for $10 right now, then the math to calculate the P/E ratio is
$10 per share in price ÷ $1 per share in earnings. That's a P/E ratio of
10.

Flip that on its side for a moment. At the current price and ratio, for
every $10 you spend to buy the stock, you buy the right to $1 in earnings.
Don't take that *too* far, however. [Earnings don't translate automatically into a dollar-for-dollar dividend](https://trendshare.org/how-to-invest/why-do-companies-pay-dividends). The company can do a lot with those
earnings. It may reinvest them or it may use them to pay taxes or they may be
an accounting fiction.

A company with no earnings—or a company which is losing
money—has no P/E ratio. Avoid it.

## What Does the P/E Ratio Mean?

The P/E ratio means nothing outside of its comparative context.  You have to
compare it to the company's P/E ratio over time, the P/E ratio of similar
companies, and the P/E ratio of the market as a whole.

## Historic PE versus Current PE

If Canada's Best Lemonade company has a historic P/E ratio of 15, that means
over the lifespan of the company people have been content to spend $15 on a
stock which generates $1 per share per year. If the ratio goes up to 20,
there's more interest in the stock for some reason—such as more demand
pushing up the price. Perhaps earnings are set to go up dramatically or there's
another company interested in buying the company or even perhaps earnings have
gone down to $0.50 a share for some reason.

If the ratio goes down to 5, the stock price may have gone down on bad news
or a major holder has sold a lot of shares and there weren't a lot of buyers or
perhaps earnings have jumped and the share price hasn't caught up to it.

Of course, if you paid $1 for a stock way back when and it currently
generates $1 in earnings every year right now, pat yourself on the back. You
have an effective PE of 1. That doesn't happen often, but if you find an
undervalued stock and its price takes off... well, that's a good investment to
own.

## Comparing Sector/Industry PE to the Current PE

One company in the lemonade business is probably like any other company in
the lemonade business. They have more similarities than differences: a critical
citrus fruit shortage may drive up supply prices or a national campaign against
citric acid in drinks may drive down demand. They all serve a similar market of
thirsty people and they all charge relatively similar prices.

When you compare the P/E ratio of one company to that of another company in
the same type of business or the same business sector, you'll get a better
understanding of how investors evaluate both companies. You still have to look
at historical norms and probably read a few news headlines to get a fuller
understanding, but you can see how investors feel about each company by
comparing this number.

The Industry P/E represents the price to earnings ratio of all companies in
that industry. Similarly the Sector P/E represents that ratio of all companies
in the sector. This can be enlightening if it illuminates substantial and
interesting differences in standout stocks.

## Comparing the Market's PE to Current PE

The market as a whole (and [the leading market indexes like the Dow, S&P 500, and NASDAQ](https://trendshare.org/how-to-invest/dow-sandp-nasdaq) each have their own P/E
ratios. This number is a snapshot of global investor sentiment. When that
number's above historic levels, you know that more money is flowing into the
market and buying shares or that earnings are going down. Similarly, when that
number is down, money may be flowing out of the market or earnings are going
up. (You need to figure out which is happening to plan your strategy.)

When you compare the Lemonade Company's P/E ratio to the market or an index
P/E ratio, you can see if the company's stock is moving with or against gestalt
market sentiment. This will help you ask questions to figure out *why*.
Perhaps the company's investing more money in expansion right now, knowing that
it'll hold down earnings now but hoping it'll help them grow faster in the
future. Perhaps it has new management that's slowly driving it out of business.
You can get hints by digging around in the news.

## What is a Good P/E Ratio?

You can't just look at this figure in isolation; you can't say that a
company with a PE ratio of 4 is a better deal than a company with a PE of 20.
Sometimes a company like [Amazon.com](/stocks/AMZN/view) is still a
valuable stock to hold, if you can buy it at a good price, because it makes
boatloads of money even though it always reinvests those earnings and never
reports them as earnings. Similarly a company that had great earnings one
quarter and has been cratering since then may have a stock price that's slowly
sinking in value as investors realize it's not worth owning. Then again, a lot
of stocks with sky high ratios *aren't* worth buying at the current
price.

Furthermore, [the change of PE over time is a good measurement of investor sentiment and financial conditions of the company](http://resourcecenter.cuna.org/24482/article/3238/html). It's a marker, but it depends on multiple
factors that you can figure out.

A [great stock at a good price](https://trendshare.org/how-to-invest/what-is-value-investing)
*probably* has a favorable P/E ratio, but you'll have to do some
research and look at a few other numbers to see if it's really a bargain. (As
well, keep in mind that the price you *paid* when you bought a stock is
fixed, and your own personal PE ratio will change as the earnings of the stock
change.)