P/E Ratio (Price-to-Earnings)

The P/E ratio (price-to-earnings ratio) is one of the most common ways to evaluate whether a stock is expensive or cheap. You calculate it by dividing the stock’s price by its earnings per share. If a company’s stock trades at $100 and it earned $5 per share last year, its P/E ratio is 20.

In simple terms, a P/E of 20 means investors are paying $20 for every $1 of profit the company makes.

Why it matters

A high P/E means investors are paying a premium, usually because they expect the company to grow quickly. Tech companies often have P/E ratios of 30, 50, or even higher. A low P/E might mean the company is undervalued, or it might mean the market sees problems ahead. Neither high nor low is automatically good or bad.

P/E ratios are most useful when you compare them to similar companies. Comparing the P/E of a Canadian bank to the P/E of a tech startup doesn’t tell you much because they’re in completely different industries with different growth expectations.

There are two versions you’ll see: trailing P/E (based on the last 12 months of actual earnings) and forward P/E (based on what analysts predict the company will earn next year). Forward P/E is a guess, so take it with a grain of salt.

The P/E ratio is a starting point, not the full picture. A company can have a great P/E and still be a poor investment for other reasons. But it’s a quick, useful way to get a sense of how the market is pricing a stock relative to what it actually earns.