Price to earnings ratio, or P/E, is a way to value a company by comparing the price of a stock to its earnings. The P/E equals the price of a share of stock, divided by the company’s earnings-per-share. It tells you how much you are paying for each dollar of earnings.
Low or high P/E ratios aren’t inherently good or bad.
When a P/E ratio is low, it could mean that investors are losing confidence, selling shares and driving the price down—while earnings hold steady. The P/E could also be low if the company’s earnings grow quickly—before investors notice and start buying shares—driving the price up.
Similarly, a high P/E could result if investor excitement drives the share price up while earnings remain low. OR—that high P/E may be justified, if the company is poised for growth.
Make sure you research companies carefully. Compare the company’s P/E to others in its industry, and analyze any inconsistencies.
P/E is a complementary tool. Use it with other factors and information when evaluating a company’s stock price.