Price to earnings ratio
Also known as: P/E, PE ratio
A ratio compares the price the market puts on a stock to something the company actually produces, its earnings, its assets, or its cash flow. It tells you how expensive a stock is relative to that measure, not just whether the share price is high or low in absolute terms.
The price to earnings ratio is the most widely quoted ratio in investing. It divides market capitalisation by net income, or equivalently the share price by earnings per share, and shows how many years of current profit it would take to earn back the price paid for the stock, assuming profit stayed flat.
The formula is: Market cap / Net income or stock price / EPS
A P/E of 35 means the market pays $35 for every $1 the company earns each year. A higher P/E typically signals that investors expect strong future growth. They are willing to pay a premium today for earnings that haven't materialised yet. A lower P/E can reflect slower growth expectations or, sometimes, undervaluation. P/E ratios are most meaningful when compared within the same sector. Technology and semiconductor equipment companies naturally trade at higher multiples than utilities or banks. Always check whether a P/E is based on trailing earnings (last twelve months) or forward earnings (next twelve months), as the difference can be significant.