Price–earnings ratio

The price–earnings ratio, also known as P/E ratio, P/E, or PER, is the ratio of a company's share price to the company's earnings per share. The ratio is used for valuing companies and to find out whether they are overvalued or undervalued.

P/E = Share Price Earnings per Share {\displaystyle {\text{P/E}}={\frac {\text{Share Price}}{\text{Earnings per Share}}}}

As an example, if share A is trading at $24 and the earnings per share for the most recent 12-month period is $3, then share A has a P/E ratio of ⁠$24/$3/year⁠ = 8 years. Put another way, the purchaser of the share is expecting 8 years to recoup the share price. Companies with losses (negative earnings) or no profit have an undefined P/E ratio (usually shown as "not applicable" or "N/A"); sometimes, however, a negative P/E ratio may be shown. There is a general consensus among most investors that a P/E ratio of around 10 to 20 is "fairly priced" but this is sector and business dependent.

Versions

There are multiple versions of the P/E ratio, depending on whether earnings are projected or realized, and the type of earnings.

"Trailing P/E" uses the weighted average share price of common shares in issue divided by the net income for the most recent 12-month period. This is the most common meaning of "P/E" if no other qualifier is specified. Monthly earnings data for individual companies are not available, and in any case usually fluctuate seasonally, so the previous four quarterly earnings reports are used and earnings per share are updated quarterly. Note, each company chooses its own financial year so the timing of updates varies from one to another. "Trailing P/E from continued operations" uses operating earnings, which exclude earnings from discontinued operations, extraordinary items (e.g. one-off windfalls and write-downs), and accounting changes. "Forward P/E": Instead of net income, this uses estimated net earnings over next 12 months. Estimates are typically derived as the mean of those published by a select group of analysts (selection criteria are rarely cited). Some people also use the formula ⁠market capitalization/ net income⁠ to calculate the P/E ratio. This formula often gives the same answer as ⁠market price/ earnings per share⁠, (if new capital has been issued it gives the wrong answer), as market capitalization = (market price) × (current number of shares), whereas earnings per share = ⁠net income/ average number of shares⁠. Variations on the standard trailing and forward P/E ratios are common. Generally, alternative P/E measures substitute different measures of earnings, such as rolling averages over longer periods of time (to attempt to "smooth" volatile or cyclical earnings, for example), or "corrected" earnings figures that exclude certain extraordinary events or one-off gains or losses. The definitions may not be standardized. For companies that are loss-making, or whose earnings are expected to change dramatically, a "primary" P/E can be used instead, based on the earnings projections made for the next years to which a discount calculation is applied.

Interpretation As the ratio of a stock (share price) to a flow (earnings per share), the P/E ratio has the units of time. It can be interpreted as the amount of time over which the company would need to sustain its current earnings in order to make enough money to pay back the current share price. While the P/E ratio can in principle be given in terms of any time unit, in practice it is essentially always implicitly reported in years, with the unit of "years" rarely indicated explicitly. (This is the convention followed in this article.)

Historical P/E ratios for the U.S. stock market

Since 1900, the average P/E ratio for the S&P 500 index has ranged from 4.78 in Dec 1920 to 44.20 in Dec 1999. However, except for some brief periods, during 1920–1990 the market P/E ratio was mostly between 10 and 20. The average P/E of the market varies in relation with, among other factors, expected growth of earnings, expected stability of earnings, expected inflation, and yields of competing investments. For example, when U.S. treasury bonds yield high returns, investors pay less for a given earnings per share and P/E's fall. The average U.S. equity P/E ratio from 1900 to 2005 is 14 (or 16, depending on whether the geometric mean or the arithmetic mean, respectively, is used to average). Jeremy Siegel has suggested that the average P/E ratio of about 15 (or earnings yield of about 6.6%) arises due to the long-term returns for stocks of about 6.8%. In Stocks for the Long Run, (2002 edition) he had argued that with favorable developments like the lower capital gains tax rates and transaction costs, P/E ratio in "low twenties" is sustainable, despite being higher than the historic average.

Set out below are the recent year end values of the S&P 500 index and the associated P/E as reported. For a list of recent contractions (recessions) and expansions see U.S. Business Cycle Expansions and Contractions.

Note that at the height of the Dot-com bubble, P/E had risen to 32. The collapse in earnings caused P/E to rise to 46.50 in 2001. It has declined to a more sustainable region of 17. Its decline in recent years has been due to higher earnings growth. Due to the collapse in earnings and rapid stock market recovery following the 2020 Coronavirus Crash, the trailing P/E ratio reached 38.3 on October 12, 2020. This elevated level was only attained twice in history, 2001–2002 and 2008–2009.

In business culture

The P/E ratio of a company is a major focus for many managers. They are usually paid in company stock or options on their company's stock (a form of payment that is supposed to align the interests of management with the interests of other stock holders). The stock price can increase in one of two ways: either through improved earnings or through an improved multiple that the market assigns to those earnings. In turn, the primary drivers for multiples such as the P/E ratio is through higher and more sustained earnings growth rates. Consequently, managers have strong incentives to boost earnings per share, even in the short term, and/or improve long-term growth rates. This can influence business decisions in several ways:

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