Imagine you’re about to buy a house.  

Two houses may cost the same, but one could be in a fast-growing neighbourhood while the other is in an area with little development. Or one could be a mansion while the other is a condominium. The value you see depends not only on the price, but also on the context.  

That is exactly what the price-to-earnings (P/E) ratio is about. It helps traders and investors judge whether a stock is fairly priced. In its simplest terms, the P/E ratio shows how much people are willing to pay for each dollar of a company’s earnings.  

But is there such a thing as a ‘good’ P/E ratio? The answer is not as straightforward as a single, fixed number—it depends on the industry, the company’s growth potential, and the broader market conditions.  

Key Points  

• A company’s P/E ratio determines how much investors are willing to pay today for a company’s past or projected earnings. 
• The P/E ratio is the company’s share price divided by its earnings per share (EPS). 
• P/E ratios can signal opportunities and risks, depending on factors such as growth potential and market conditions. 

What Is the P/E Ratio in Stocks?  

In simple terms, the P/E ratio shows how much investors are paying for each dollar a company earns.  

Some look at past earnings (trailing P/E), while others focus on future expectations (forward P/E)—a key difference we’ll unpack further in the next sections. But first, let’s understand what the P/E ratio means on its own.  

Formula:  

P/E = Share Price ÷ Earnings per Share (EPS) 

• Share Price = The current market price of one share. 
• EPS = The company’s earnings divided by the number of outstanding shares. 

In short, it’s answering the question “How many dollars do I need to pay for one dollar of this company’s earnings?” so that investors don’t pay too much.  

Read More: Earnings vs Forecast: Why Forward Guidance Can Have a Bigger Impact Than Results   

How Do You Calculate the P/E Ratio?  

To calculate the P/E ratio, let’s break it down step by step: 

1. Find the company’s current share price. 
2. Look up the EPS. 
3. Divide the share price by the EPS. 

Example: 

• Share price of company A = $100 
• EPS = $5 
• P/E ratio = $100 ÷ $5 = 20 

In this scenario, investors are paying $20 for every $1 of Company A’s earnings. 

Comparison Table: 

Company	Share Price	EPS	P/E Ratio
Company A	$100	$5	20
Company B	$50	$2	25
Company C	$200	$20	10

Note: This example assumes share prices remain constant for simplicity—in live markets, actual prices fluctuate and may impact investing outcomes. 

On its own, a lower share price does not necessarily mean a stock is of better value. Using the above comparison table to illustrate, Company B has a lower share price than Company A, but its P/E is higher, suggesting that investors are paying more for every dollar of its earnings. Meanwhile, Company C has the lowest P/E ratio despite having the highest share price, which may translate to a stronger value for some investors. 

This is why the P/E ratio is most useful when comparing companies within the same industry, as it allows for true “apples-to-apples” comparisons.  

What Is Considered a Good P/E Ratio? 

A ‘good’ P/E ratio is relative.  

On average, many investors consider a P/E between 15 and 25 to be reasonable¹. However, that’s not a one-size-fits-all range: 

• Technology stocks often trade at higher P/Es (30 to 50+), reflecting strong growth expectations². 

• Examples: Nvidia, Apple, Microsoft, Amazon—all of which typically command premium valuations due to innovation and earnings growth potential³. 

• Utility companies usually have lower P/Es (10 to 15), as they offer steady but slower growth². 
• Examples: SM Energy, Mazda, Western Union—oil and gas, auto manufacturers, and credit services, among others³.  

Asking “What is a good P/E ratio?” is similar to asking “What is a good speed for driving?” On a highway, 100 km/h may be fine, but in a city, it would be reckless.  

As always, context is what makes the difference.  

Related Article: Best Artificial Intelligence Stocks to Watch Out For  

What Is a High vs. Low P/E Ratio?  

In general, a high P/E ratio often reflects strong investor optimism, as the market expects a company’s earnings to grow quickly in the future. However, it can also indicate higher risk, since investors are paying a premium that only holds up if those growth expectations are met. 

Conversely, a low P/E ratio might suggest a stock is undervalued and potentially a bargain. But it can also signal weaker fundamentals or slowing growth that the market has already priced in. 

But is ‘expensive’ always bad, and is ‘cheap’ always good?  

The answer: Not necessarily. Using the three companies mentioned earlier as an example, here’s why: 

Company	Share Price	Trailing 12-Month EPS	Trailing P/E Ratio	Projected EPS (next 12m)	EPS Growth Outlook
A	$100	$5.00	20	$5.50	+10% per year
B	$50	$2.00	25	$2.04	+2% per year (slow)
C	$200	$20.00	10	$19.80	–1% (flat/declining)

Note: This example assumes share prices remain constant for simplicity—in live markets, actual prices fluctuate and may impact investing outcomes. 

At first glance, Company C looks like the cheapest option with a P/E of 10 (highlighted in yellow), while Company B looks the most expensive with a P/E of 25 (highlighted in red).  

But here’s the catch: P/E ratios only make sense when you also consider earnings growth, and by extension, its forward P/E (see next section for more details.). 

• Company A: Higher trailing P/E ratio of 20, but strong future growth expectations might justify it. 
• Company B: High trailing P/E ratio of 25 with relatively little future growth expectations could make it look risky to some investors. 
• Company C: Low P/E of 10 looks cheap, but its declining future earnings growth raises red flags. 

So, is a low P/E always good and a high P/E always bad? Not exactly. To see why, investors often add another lens: the forward P/E ratio. 

What Is Trailing P/E vs. Forward P/E?  

The P/E ratio measures how much investors are willing to pay for a company’s earnings, but not all P/E ratios are the same.  

The trailing P/E ratio is typically calculated using the last 12 months of a company’s actual reported earnings per share (EPS), also known as the trailing twelve months (TTM). It shows how many times investors are currently paying for the company’s past profits.  

• Formula: Current Share Price ÷ Trailing 12-Month EPS (last 12 months or “TTM”)  
   

Meanwhile, forward P/E is usually calculated using analysts’ projections of earnings for the next 12 months. It reflects how much investors are willing to pay for the company’s expected future profits. 

• Formula: Current Share Price ÷ Estimated Future EPS (next 12 months)  
   

Think of it as checking both your past expenses (trailing P/E) and your future budget (forward P/E) before deciding to make a big purchase. 

To better illustrate this, let’s take the example of Company A. The company’s info is as follows:  

• Current share price: $100 
• Trialing 12-month EPS: $5.00 → Trailing P/E = $100 ÷ $5 = 20 
• Estimated future EPS (assuming +10% growth):  

1. Start with current EPS: $5.00 
2. Apply projected growth: $5.00 × (1 + 10%) = $5.50 

2. Forward P/E = $100 ÷ $5.50 = 18.2 

Company A looks expensive if you only look at its trailing P/E ratio. But once an investor factors in its future earnings, the forward P/E ratio shows the stock becoming relatively cheaper as growth kicks in.  

Now, let’s revisit the three companies with their forward P/E ratios for a more comprehensive evaluation: 

Company	Trailing P/E Ratio	Projected EPS (next 12m)	Forward P/E Ratio	Evaluation
A	20	$5.50	18.2	Growth largely justifies higher valuation
B	25	$2.04	24.5	Premium could be hard to defend
C	10	$19.80	10.1	Cheap but signals weak confidence to some investors

Note: This example assumes share prices remain constant for simplicity—in live markets, actual prices fluctuate and may impact investing outcomes. 

• Company A: Despite starting with a higher P/E, its strong EPS growth quickly justifies the price, and its forward P/E ratio trends lower over time. 
• Company B: With sluggish growth, its high P/E is harder to defend, leaving investors paying a premium without much growth to support it. 
• Company C: Although it looks cheap on paper, its flat or declining earnings in the future mean its low P/E ratio may not signal value and could simply reflect weak investor confidence. 

The key takeaway is that a stock with a high trailing P/E ratio may look expensive today. But if its earnings grow strongly, some investors could perceive its forward P/E ratio as attractive.  

On the other hand, a low trailing P/E might seem like a bargain. However, if the company’s growth stalls, its forward P/E ratio will not improve—and the stock could remain cheap for all the wrong reasons.  

Related Article: Value vs Growth Stocks: Which One Suits You?  

What Are the Limitations of the P/E Ratio?  

The P/E ratio is popular because it’s simple to calculate and easy to understand. But that very simplicity can be risky if used in isolation.  

A low P/E ratio doesn’t always mean a stock is undervalued—sometimes, a stock is ‘cheap’ because the market expects weaker performance ahead. Conversely, a high P/E doesn’t necessarily mean a stock is overpriced as ‘expensive’ stocks can still deliver strong long-term returns.  

Companies like Amazon, for example, traded at elevated P/E levels for years—sometimes above 200⁴—yet still rewarded investors as earnings growth consistently outpaced expectations. 

Another limitation is that earnings themselves can be misleading. That’s because EPS is based on accounting profits, which can be affected by non-cash items, one-off adjustments, or even financial engineering.  

Case in point: A fast-growing tech firm may report positive EPS while still having negative free cash flow—meaning it spends more cash than it generates.  

Ultimately, the P/E ratio offers a quick valuation snapshot—but it should never be the sole metric. Investors often pair it with other tools of fundamental analysis such as price-to-book (P/B), price-to-sales (P/S), debt ratios, and free cash flow analysis.  

Think of P/E ratio as a guidepost, not a final verdict.  

Learn More: Basics of Fundamental Analysis  

What Are Some P/E Ratio Examples Across Industries?  

P/E ratios also vary dramatically between industries, which is why cross-industry comparisons can mislead investors. Tech companies often carry higher P/Es because investors expect rapid growth, while utilities or banks typically trade at lower P/Es because they offer stability but slower expansion. 

Here’s how P/E ratios can look across sectors: 

Company	Sector	Trailing P/E (TTM)	Forward P/E
Nvidia (NVDA)	Semiconductors	~50.21	~39.37
AMD (AMD)	Semiconductors	~94.56	~26.60
Tesla (TSLA)	Automobiles	~248.12	~163.93
Apple (AAPL)	Consumer Tech	~36.10	~29.67
Microsoft (MSFT)	Consumer Tech / Software	~37.28	~32.89
JPMorgan Chase (JPM)	Banking & Finance	~16.06	~15.48

Note: Abovementioned P/E ratios are taken from Yahoo! Finance as of the time of writing. Trailing and forward P/Es come from analyst consensus and will vary by provider. 

As mentioned earlier, P/E ratios are most useful when comparing companies in the same industry.  

For instance, comparing Apple to Tesla could provide investors with some insight, but since they’re in different sub-sectors, it’s less precise. A better comparison would be comparing Apple to Microsoft or Nvidia to AMD since they operate in similar markets.  

P/E Is a Starting Point, Not the Full Picture  

The P/E ratio is one of the most widely used valuation tools in the stock market. It gives traders a snapshot of how the market values a company’s earnings—but it’s not a crystal ball. What counts as a good P/E ratio depends on the sector, growth outlook, and overall market mood. 

Rather than relying on it in isolation, pair the P/E ratio with other valuation measures and fundamental analysis to gain a clearer, more balanced view of potential opportunities.  

To learn more, visit the Vantage Academy.  

References