How To Use P/E Ratio To Value Stocks? A Complete Guide
If you look at stock quotes, you will almost always see a P/E ratio next to the price. It is one of the simplest and most widely used valuation metrics in investing.
At its core, the price to earnings (P/E) ratio tells you how much investors are willing to pay today for 1 dollar of a company’s earnings.
Used correctly, it helps you compare companies, spot extremes in valuation and frame expectations about future growth.
P/E Ratio Meaning
The P/E ratio compares:
- Price: the current market price per share
- Earnings: the company’s earnings per share over a period, usually 12 months
In simple terms:
P/E ratio shows how many dollars investors pay for each dollar of earnings.
- A P/E of 10 means you pay 10 dollars for 1 dollar of earnings
- A P/E of 25 means you pay 25 dollars for 1 dollar of earnings
Higher P/E usually means higher growth expectations, lower P/E often signals lower growth or higher perceived risk.
How To Calculate P/E Ratio
The basic formula is:
P/E Ratio = Share Price ÷ Earnings Per Share (EPS)
Example
- Share price: 50 dollars
- Earnings per share over the last year: 5 dollars
P/E ratio = 50 ÷ 5 = 10
Investors are paying 10 times last year’s earnings for that stock.
What Is A “Good” P/E Ratio?
There is no universal “good” P/E that fits every stock, context matters.
Compare to the company’s own history
- A stock trading at 15 times earnings today might be cheap if it usually trades around 25
- The same stock might be expensive if its long term average is 10
Compare within the same sector
Different industries have different typical P/E ranges.
- Mature, stable sectors like utilities often have lower P/Es
- High growth sectors like technology often carry higher P/Es
Comparing a bank’s P/E to a cloud software company’s P/E rarely makes sense.
It is far more useful to compare banks to banks and software to software.
Think in terms of growth
In simple terms:
- High P/E can be reasonable if earnings are growing fast
- Low P/E can be a value opportunity, or a warning sign of weak or declining earnings
This is why many investors also look at the PEG ratio (P/E divided by growth rate) to see if valuation roughly matches growth.
How Retail Investors Can Use P/E?
You do not need to be a professional analyst to use P/E in a practical way.
1. Quick valuation check
Use P/E to do a first pass:
- Is this stock much more expensive than its sector
- Is it far cheaper than peers, and if so, why
This helps you decide which companies deserve a deeper look.
2. Screen for ideas
Many stock screeners let you filter by P/E range, for example:
- P/E between 10 and 20 for “reasonably priced” companies
- P/E under 15 for potential value ideas
It does not replace research, but it narrows a large universe.
3. Frame your expectations
A very high P/E means the market expects a lot of future growth. If that growth disappoints, the stock can fall sharply even if the business is still good.
A low P/E might mean low expectations. If the company stabilises or improves even slightly, the stock can rerate higher.
Limitations Of P/E Ratio
The P/E ratio is popular because it is simple, but it also has clear limits.
1. Earnings can be noisy
Earnings can be affected by one off items such as asset sales or write downs. This can make P/E temporarily look very high or very low.
2. Not useful for companies with no profits
If earnings are zero or negative, P/E cannot be used. Many early stage growth companies fall into this category.
3. Ignores balance sheet strength
P/E focuses only on price and earnings, not on debt or cash. Two companies with the same P/E can have very different financial risk.
4. Market mood can distort P/E
In bubbles, P/E ratios can climb far above normal levels. In panics, they can fall to extremes on the downside.
This is why P/E should be combined with other metrics such as free cash flow, margins, growth and debt levels.
Conclusion
The P/E ratio is one of the simplest tools to understand how the market values a company’s earnings. By comparing price to earnings, you can quickly see whether investors are paying a low, fair or high multiple relative to the company’s history and its sector.
On its own, P/E does not tell you if a stock is a buy. Used alongside growth, balance sheet strength and business quality, it becomes a powerful filter to avoid extremes and focus on companies where price and fundamentals are better aligned.
If you want to practice reading P/E ratios on real US stocks and ETFs, apps like Gotrade let you start with small amounts and fractional shares, so you can learn valuation in a hands on way while keeping your risk under control.
FAQ
- Is a low P/E ratio always good?
Not always. A low P/E can mean a stock is undervalued, but it can also signal weak growth, high risk or structural problems in the business. - Why do tech stocks often have high P/E ratios?
Many tech companies grow earnings faster than mature sectors. Investors are willing to pay higher multiples today because they expect stronger future profits. - Should I use trailing or forward P/E?
Both are useful. Trailing P/E shows what the business has actually earned, forward P/E shows what the market expects. It helps to look at them together.
Reference:
- Investopedia, Price-to-Earnings (P/E) Ratio: Definition, Formula, and Examples, 2026.
Disclaimer:
Gotrade is the trading name of Gotrade Securities Inc., which is registered with and supervised by the Labuan Financial Services Authority (LFSA). This content is for educational purposes only and does not constitute financial advice. Always do your own research (DYOR) before investing.
