Price-to-Earnings Ratio

The price-to-earnings (P/E) ratio is a popular measure investors use to compare valuations for stocks, industry sectors and broad markets. For example, if a stock price is $50 and the earnings are $2 per year, the P/E ratio is 25. Suppose the average P/E is 32 for the stock's industry sector. Then you can infer the stock is selling at a lower P/E than its peer group. If the industry P/E were 20, the stock is more expensive than the industry average.

You can use current, trailing or future earnings to compute a P/E.

In general, fast-growing companies and sectors have higher P/Es than slower growing companies and sectors. Often a high P/E stock is anticipating future earnings.

The next chart shows historical P/Es for the S&P market index is based on data from Robert Shiller.

The P/E was over 46 for the 2000 bubble.

Check P/E Before You Buy and Sell

Before you buy a stock, check its P/E. If the P/E is high relative to its historical P/E and or its sector P/E beware. You may be paying too much.

If you own a stock, check its P/E to help you make a sell decision. If the P/E is relatively high, it may be time to sell.

Related Articles:

Estimating a Stock's Future Price Using Earnings and P/E
Valuation Measures

Updated July 26, 2007.