What does a high P/E ratio mean?
Is the P/E ratio the same for all industries?
Can the P/E ratio be negative?
What is the difference between trailing and forward P/E?
Why is P/E ratio important to investors?
The P/E ratio, or Price-to-Earnings ratio, is one of the most widely used metrics for valuing a stock. It helps investors assess whether a stock is undervalued, overvalued, or fairly priced, particularly when considered alongside the company’s expected growth rate. It’s also useful for comparing a stock’s valuation with peers or the broader market.
As a general guideline, a P/E of around 15 is often seen as fair value for moderately growing, established companies. However, this benchmark may not apply to young or rapidly growing businesses.
There are several variations of the P/E ratio—such as trailing P/E, forward P/E, and blended P/E—which we’ll cover later in this article. While the P/E ratio is the most common valuation tool, others include P/S (Price-to-Sales), P/EBITDA (Price-to-EBITDA), and more.
The P/E ratio is pretty straightforward: take the current stock price and divide it by the company’s earnings per share (EPS).
For example, if a stock is trading at $45 and its EPS is $3, the P/E ratio would be 15x (45 ÷ 3). You’ll often see P/E ratios expressed as a multiple—essentially that number followed by an “x.”
The twist is that stock prices change every day, while EPS is only updated quarterly. That timing gap is why there are different ways to calculate it. A trailing P/E looks back at the company’s actual earnings over the past 12 months (TTM). A forward P/E uses earnings forecasts for the next year. And a blended P/E mixes the two for a more balanced view. Each approach offers a slightly different perspective, so knowing which one you’re looking at can help you make better investing decisions.
The trailing P/E is the most common version of the P/E ratio. It’s calculated by dividing the current stock price by the total EPS from the last four reported quarters. Investors like it because it’s based on actual, reported numbers—not forecasts or guesses. But that’s also its biggest weakness.
Stocks are bought for their future potential, not their past performance. You don’t get a share of what the company earned last year—you’re investing in what it’s going to earn next. That means the trailing P/E can sometimes misrepresent a stock’s true value, giving you an outdated picture of its potential.
Take this example: a company has a trailing 12-month (TTM) EPS of $5 and trades at $100 per share. That’s a TTM P/E of 20x, which, as we mentioned earlier, could be considered overvalued. But if next year’s earnings are expected to jump to $7 per share, the P/E based on those projections would drop to about 14x—potentially undervalued.
And that’s exactly where the forward P/E comes in, offering a view of valuation based on what a company is expected to earn next.
The forward P/E looks ahead instead of back. It’s calculated by taking the current stock price and dividing it by the company’s projected earnings per share for the next fiscal year. These estimates typically come from analysts, the company itself, or a combination of both.
The advantage of the forward P/E is that it focuses on where the company is headed. If earnings are expected to grow, the forward P/E will usually be lower than the trailing P/E, signaling that the stock might be more attractively valued than it first appears. On the other hand, if earnings are expected to decline, the forward P/E will likely be higher—an early warning sign for investors.
Of course, the downside is that these earnings projections aren’t guaranteed. Markets change, business conditions shift, and even the best forecasts can miss the mark. This is where the blended P/E comes into play. It bridges the gap between historical results and future expectations.
The blended P/E combines historical earnings with forecasted earnings to give what’s often the most accurate snapshot of a stock’s current valuation. The key is using a time-weighted average that shifts as the year progresses.
Think of it like a sliding scale between the last fiscal year’s actual results and the next fiscal year’s estimates. Early in the year, the most recent actual earnings carry most of the weight, while estimates for the next year have little influence. As the months go by, the weighting gradually shifts—around mid-year it’s closer to a 50/50 split—and by the end of the year, the estimates carry most of the weight while the year-old actuals have almost none.
This time-weighted approach smooths the transition between historical data and future expectations, giving investors a more up-to-date view of valuation. The benefit is balance—you get the reliability of reported results while still factoring in what’s expected ahead.
The main limitation is that forward estimates are still forecasts, and they can be wrong if analysts misjudge the company’s performance. But when done correctly, the blended P/E often provides one of the most accurate snapshots of a stock’s current valuation. It’s the method used on FAST Graphs, so when you see a P/E multiple displayed on the chart, it’s calculated using this blended approach.
The PEG ratio measures the relationship between a company’s P/E ratio and its growth rate, giving investors another lens to judge whether a stock might be undervalued or overvalued. It’s calculated by dividing the P/E ratio by the company’s growth rate—most often an estimated rate for the next few years, though historical growth can also be used for analysis.
For example, if a company has a P/E of 15 and an expected growth rate of 20%, the PEG ratio would be 0.75 (15 ÷ 20).
As a general rule of thumb, a PEG below 1 suggests a stock may be undervalued, while a PEG above 1 suggests it may be overvalued. But context matters. The PEG ratio is most useful for companies expected to grow faster than 15% per year. Many slower-growing businesses may have PEGs well above 1 without being truly overvalued—especially since historically, most slow-to-moderate-growth companies tend to trade around a P/E of 15, which can put their PEG ratios near 3.
The earnings yield is simply the inverse of the P/E ratio. It’s calculated by dividing a company’s earnings per share (EPS) by its share price—or more simply, 1 divided by the P/E—and is usually expressed as a percentage.
For example, if a stock has a P/E of 15, the earnings yield would be 0.0667 (1 ÷ 15), or 6.67%. This tells you the “yield” of an equity investment, making it easier to compare to fixed-income instruments like bonds. A P/E ratio of 15 doesn’t intuitively line up with a bond yielding 4%, but an earnings yield of 6.67% gives you a direct point of comparison.
Of course, unlike a bond yield, the earnings yield isn’t a guaranteed rate of return—it’s a snapshot of the company’s earnings relative to its current price. For example, a stock could have a P/E of 15 today and a P/E of 15 five years from now, but if earnings grew 20% annually during that time, so would the value of the investment. In other words, the earnings yield shows the current relationship between price and earnings, not the total growth you might experience over time.
For low- to moderate-growth stocks, valuations tend to hover around a P/E of 15. Anything much higher can start to feel expensive. That’s because a P/E ratio can be thought of as the number of years it would take to recoup your investment if you owned 100% of the company and took all the earnings for yourself. A P/E of 15 essentially means it would take 15 years of current earnings to pay back your purchase.
With slow-growing companies, valuation discipline matters even more—you don’t want to overpay for a business that can’t produce enough additional earnings quickly. For example, if you pay a 15 P/E for a company growing 5% per year, it would take about 11.5 years to earn your money back. Pay a 20 P/E for that same company, and you’re looking at just over 14 years—a 2.5-year difference.
On the other hand, it’s much harder to overpay for a fast-growing company. If you buy at a 20 P/E for a business growing earnings at 20% per year, you’d recoup your investment in just over 9 years. Even paying a 25 P/E would stretch that to just under 10 years—not even a full year longer. This is exactly why the PEG ratio (P/E divided by growth rate) can be so useful: for the 20% growth example, the PEG is 1.0 at a 20 P/E and only 1.25 at a 25 P/E—both in a range that can still be attractive for a high-growth stock. In other words, the PEG helps put the P/E into context by showing how much you’re really paying for each percentage point of growth.
An investor shouldn’t base their entire decision on a P/E ratio alone. While it’s a useful snapshot of valuation, it’s only one piece of the puzzle. Other metrics and a deeper look at a company’s financials are just as important. As mentioned earlier, past performance doesn’t guarantee future results, so factoring in the company’s estimated growth, industry trends, and broader economic conditions is essential.
The P/E ratio also means different things depending on a company’s stage of maturity. For example, a young, fast-growing business that’s focused on revenue growth rather than profitability will often have a very high P/E—or no P/E at all if earnings are negative. In those cases, the P/E isn’t particularly meaningful.
The P/E ratio is one of the most widely used tools in an investor’s toolkit, offering a quick way to gauge valuation and even compare a stock to other investment opportunities. It’s a powerful starting point for analysis, but it tells only part of the story.
On its own, the P/E can’t capture the full picture of a company’s potential. True investment insight comes from pairing it with other measures—like growth expectations, profitability, balance sheet strength, and the overall economic environment. Used this way, the P/E ratio becomes not just a number, but a valuable piece of a broader, well-rounded decision-making process.
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