Price-to-Earnings Ratio

In one sentence: The P/E ratio says how many dollars investors pay today for each dollar of a company’s yearly earnings per share.

$\text{P/E} = \frac{\text{Price per share}}{\text{Earnings per share}}$

Read it out loud: “P E equals price per share divided by earnings per share. P E is the price-to-earnings ratio, a plain number. Price per share is what one share costs, in dollars per share. Earnings per share is the profit for one share over a year, also in dollars per share. So the ratio says how many dollars of price there are for each dollar of yearly earnings.”

Before you start

The ideas and signs this page uses, explained from zero. For powers of ten, Greek letters and other notation in general, see Math basics.

A share and its price: A share is one equal part of a company’s ownership, and its price is the amount you must pay to buy one share on the market. The price is measured in dollars per share, so 15 dollars per share means one share costs 15 dollars at that moment. The price is set by what buyers and sellers agree to, and it changes from day to day.
Earnings per share: Earnings per share is a company’s profit for a year divided by its number of shares. If a company earned 500000 dollars for the year and has 1000000 shares, its earnings per share is 0.50 dollars per share. It is measured over a whole year, not at one moment.
Ratio: A ratio compares two amounts by dividing one by the other. A ratio can be written as a fraction, where the bar means divide. When the units on top and bottom are the same, they cancel, so the answer is a plain number. A P/E of 30 is read as 30 times, or 30 dollars for each dollar of yearly earnings.
Snapshot and yearly total: A price is a snapshot, measured at one moment in time. Earnings are a total over a period, usually a year. The P/E ratio compares that one-moment price with the yearly total, so it is a comparison of two different kinds of number.

What each symbol means

Symbol	Meaning
$\text{P/E}$	The price-to-earnings ratio, the number the formula gives. It has no unit of its own, because dollars per share divided by dollars per share leaves a plain number. A P/E of 30 means investors pay 30 dollars for each 1 dollar of yearly earnings per share.
$\text{Price per share}$	Price per share, the price at which one share of the company’s stock is bought or sold, measured in dollars per share. It changes as buyers and sellers agree on new prices.
$\text{Earnings per share}$	Earnings per share, the company’s profit for a year divided by its number of shares, measured in dollars per share. It is the same figure explained on the earnings per share page. It must be above zero for the ratio to be useful.

The formula piece by piece

$\text{Price per share}$: Start with the price that investors pay for one share today, in dollars per share. This is the number that a stock market shows at a moment in time, so it is the amount a buyer pays now.
$\text{Earnings per share}$: Next, the profit that lies behind one share over a whole year, in dollars per share. It is measured over a full year, so the two numbers come from different periods: the price is a moment and the earnings are a year.
$\text{P/E} = \frac{\text{Price per share}}{\text{Earnings per share}}$: The whole formula in one sentence: the price-to-earnings ratio equals the price per share divided by the earnings per share, which says how many dollars of price there are for each dollar of yearly earnings.

What the formula is doing, and why

The P/E ratio compares what a share costs with what the company earned for that share. The price is what buyers pay today. The earnings per share is what the company made for that share over a year. Dividing one by the other tells you how many dollars of price you are paying for each dollar of that yearly profit.

Why divide? Division answers a how-many-times question. If a share earns 1 dollar a year and costs 30 dollars, you are paying 30 times its yearly earnings. A higher P/E means buyers pay more for each dollar of earnings, and a lower P/E means they pay less.

What the number is not. A P/E is not a promise that the price will rise or fall, and it is not a forecast. It is a snapshot: the price today compared with the past year’s earnings. The number depends on the price on the day it is measured, so it changes whenever the price changes, even if the company’s earnings stay the same.

Why the earnings must be above zero. If a company lost money for the year, its earnings per share is zero or negative. Dividing a price by zero, or by a negative number, does not give a useful answer, so a P/E is usually treated as not meaningful for a company that made a loss.

There are two common versions. The trailing P/E uses the earnings of the last twelve months. The forward P/E uses an estimate of the next year’s earnings. The formula is the same in both cases, and only the earnings figure changes.

An everyday picture

Think of a small shop that makes 1000 dollars of profit each year. If the owner asks 30000 dollars for it, the price is 30 times the yearly profit, so the P/E is 30000 divided by 1000, which is 30. A buyer who asks for the same shop at 15000 dollars is paying 15 times its yearly profit. The P/E is the price tag divided by the yearly profit, and the same arithmetic works for a share.

Worked example: P/E for Blue Kettle Coffee at 15 dollars per share

Blue Kettle Coffee, the made-up company from the earnings per share page, has earnings per share of 0.50 dollars for the year. Its shares trade at 15 dollars each. We want its P/E, the earnings yield that the same numbers imply, and the P/E if the price rose to 20 dollars while the earnings stayed the same.

Write down the two numbers in the same units. Both the price and the earnings per share are measured in dollars per share, so they can be divided directly. The price is 15 dollars per share, and the earnings are 0.50 dollars per share. Using the same units means the answer will be a plain number.
Divide the price by the earnings. The formula says the P/E equals the price per share divided by the earnings per share, so $\text{P/E} = \frac{15\ \text{dollars per share}}{0.50\ \text{dollars per share}} = 30$ . Dividing by 0.50 is the same as multiplying by 2, and 15 times 2 is 30. The units cancel, leaving the plain number 30.
Read the answer in words. A P/E of 30 says that buyers are paying 30 dollars today for every 1 dollar that one share earned over the past year. That is the whole meaning of the number. It does not say whether the price is right, because that depends on other facts.
Find the earnings yield for the same share. The earnings yield is the earnings divided by the price, which is the flip of the P/E: $\frac{0.50\ \text{dollars}}{15\ \text{dollars}} \approx 0.0333$ , or 3.33%. It is the earnings for each dollar paid. Dividing 1 by the P/E of 30 gives the same 0.0333, so the two views agree.
Work out the P/E if the price rises to 20 dollars. The earnings stay at 0.50 dollars per share, so the new ratio is $\frac{20\ \text{dollars per share}}{0.50\ \text{dollars per share}} = 40$ . The same company earning the same amount now looks more expensive, because each dollar of earnings costs 40 dollars of price instead of 30.
Check the first answer by multiplying back. If the P/E is 30, then 30 times the earnings should give the price: $30 \times 0.50 = 15$ dollars, which matches the price we started with. Running the division in reverse brings back the starting number, so the answer is consistent.

Answer: At 15 dollars per share, Blue Kettle Coffee has a P/E of 30, so buyers pay 30 dollars for each 1 dollar of yearly earnings per share. If the price were 20 dollars with the same earnings, the P/E would be 40. These are worked numbers for practice, not a judgment about the company.

The numbers in this example are recomputed by script every time the site is built.

Common mistakes

Dividing the earnings by the price instead of the price by the earnings. A result of 0.033 is the earnings yield, not the P/E.
Using a company’s total profit in place of earnings per share. The P/E compares the price of one share, so the earnings must also be per share.
Reading a high P/E as always bad, or a low P/E as always cheap. The number depends on what the company is expected to earn, and it must be read alongside other facts.
Trying to use a P/E when earnings are negative. A loss gives a negative or meaningless ratio, so no sensible reading can be made from it.

Where you will meet it

Financial news and stock tables, where the P/E is listed beside each company’s share price.
Comparing a company’s current P/E with its own past values over several years.
A quick first check on how expensive a share is compared with its yearly earnings, before a more detailed study.
Describing how expensive a whole stock market is, using the earnings of the companies in it.

Questions people ask

Is a high P/E ratio bad?

Not on its own. A high P/E means buyers are paying more for each dollar of earnings. That can happen when buyers expect earnings to grow quickly, and it can also mean the price is high for the earnings now. The number alone does not say which.

What is the difference between trailing and forward P/E?

The trailing P/E divides the price by the earnings of the last twelve months. The forward P/E divides the price by an estimate of next year’s earnings. Both use the same formula, but the earnings figure is different.

Why does the P/E change every day?

The price changes as buyers and sellers trade. Earnings per share changes only when the company reports new results, so the P/E moves mostly with the price.

Earnings Per Share: EPS says how much profit a company earned for each share of its stock, after the preferred shareholders have been paid their dividends.
Dividend Yield: Dividend yield says how much cash a company pays out each year, as a percentage of the price you would pay for one share.
Gordon Growth Model: The Gordon growth model says a share is worth its next dividend divided by the gap between the return you want and the rate the dividend grows.