What it measures
The price-to-earnings ratio is the share price divided by Earnings per share (EPS). It tells you how many dollars you pay for each dollar of yearly profit. A P/E of 20 means you pay $20 for $1 of earnings.
Flip it over and you get the earnings yield: a P/E of 20 is a 5% earnings yield.
Trailing versus forward
- Trailing P/E uses the last twelve months' actual EPS.
- Forward P/E uses the analysts' expected EPS for the next twelve months. For growing companies it is lower than trailing, and it is the more useful of the two because the price is paying for the future. See forward P/E in the glossary.
How to read it
A P/E only means something when compared:
- With growth. A P/E below the company's EPS growth rate is usually attractive. P/E 26 with 32% growth is cheaper than P/E 11 with 4% growth. The PEG ratio puts this in one number.
- With its sector. Software trades at higher P/Es than banks. Compare within an industry.
- With its own history. A company at a P/E of 35 when its five-year average is 25 needs faster growth to justify it.
P/E compression
Growth shrinks P/E over time if the price stands still. Paying a high multiple for a fast grower can work out because the multiple falls as earnings catch up. See EPS growth (TTM and forward) for the worked example.
| Year | EPS (growing 25%) | P/E at a $100 price |
|---|---|---|
| Today | $4.00 | 25 |
| +1 | $5.00 | 20 |
| +2 | $6.25 | 16 |
| +3 | $7.81 | 12.8 |
Caveats
- Cyclical companies look cheapest at the peak of the cycle, when earnings are temporarily high.
- Unprofitable companies have no meaningful P/E; use Price-to-sales ratio (P/S).
- Accounting items can distort EPS; check Free cash flow too.
Questions
What is a good P/E ratio?
There is no single good number. The long-run average for the S&P 500 is around 15 to 20. A P/E is reasonable when it is roughly at or below the company's earnings growth rate; that comparison is the PEG ratio.
What does a negative P/E mean?
The company lost money over the period, so there are no earnings to divide by. P/E is not meaningful until it is profitable; use price-to-sales instead.
See also
- PEG ratio The PEG ratio divides the P/E by earnings growth, so it judges valuation and growth together. What the bands mean and how to use it.
- EPS growth (TTM and forward) How to read earnings per share growth, why it can outpace revenue through operating leverage, and how buybacks can flatter it.
- Earnings per share (EPS) What earnings per share means, basic versus diluted EPS, GAAP versus adjusted EPS, and how EPS connects profit to the share price.
- EV/EBITDA EV/EBITDA values a whole company, debt included, against its operating cash earnings. How enterprise value works and when to use it over P/E.
Pages that link here: Building a research watchlist, Building your investing knowledge, Fundamental analysis, Fundamentals checklist, Fundamentals vs technicals, Growth, value and dividend investing, How to research a company, Hype and market sentiment, Investing in IPOs, Mean reversion, Price-to-sales ratio (P/S)
Last updated September 30, 2026. Education only, not investment advice.