Price-to-Earnings Ratio

The price-to-earnings (P/E) ratio compares what investors are paying for one share of a company with the amount of profit that share currently generates. It is useful because earnings per share acts as a rough measure of the profit available to each share, so dividing price by EPS shows how many dollars investors pay for one dollar of annual earnings. A higher P/E usually suggests investors expect stronger future growth or lower risk, while a lower P/E can suggest weaker growth expectations or a potentially undervalued stock.

Use this ratio when comparing how expensive or cheap different stocks look relative to their earnings, especially within the same industry. It is also useful when checking whether a share price seems reasonable based on the company’s recent profitability.

• Using total company profit instead of earnings per share
• Comparing P/E ratios across very different industries without context
• Forgetting that a negative or very small EPS can make the ratio misleading or unusable