The P/E (Price/Earnings) Ratio

What You’ll Learn

How to read the P/E ratio and decide cheap-vs-expensive in 60 seconds.

Content

P/E ratio: stock price divided by annual earnings per share (EPS). Formula: P/E = Price / EPS. Meaning: how many dollars does an investor pay for $1 of earnings?

Example: AAPL at $230, annual EPS $6.50. P/E = 230 / 6.50 ≈ 35. “Investors pay $35 for each $1 of earnings.” Payback period (if earnings stable): 35 years.

P/E ranges (S&P 500 general):

• Very low (<10): value stock or troubled company.
• Mid (15-20): mature, balanced.
• High (20-30): growth expectation.
• Very high (>30): high-growth or overvalued.

Is low P/E always good? No. It can signal hidden problems: high debt, sector crashed, weak management. Compare with sector average. Bank P/E 8 is normal; tech P/E 8 raises eyebrows.

Is high P/E always bad? No. Fast-growing companies sell future earnings. NVDA P/E 60 with 60%+ earnings growth. Over the next 1-2 years P/E falls naturally if growth holds.

Sectors get different P/E:

• Banking: 8-12
• Auto: 8-15 (cyclical)
• Retail: 15-25
• Technology: 20-40
• Biotech: 30+ Compare each sector within itself.

P/E limitations: don’t decide on it alone. EPS can be manipulated and may be one-year. Combine with P/B, EV/EBITDA, and DCF. Modules 3-5 deepen this.

Quiz

Question 1: P/E formula?

• A) Price × EPS
• B) Price / EPS (Correct)
• C) Price / Debt
• D) EPS / Price

Question 2: P/E = 25 means what?

• A) 25% return
• B) Pay $25 for $1 of earnings (Correct)
• C) 25-year earnings growth
• D) 25% dividend

Question 3: Is a low P/E (5) always good?

• A) Yes
• B) No — it can signal company problems (Correct)
• C) Only for older investors
• D) Only for bank stocks

Question 4: Best P/E approach?

• A) Decide on it alone
• B) Compare to sector average + use other ratios (Correct)
• C) Random pick
• D) Read social media

Action

Open Yahoo Finance or your broker. Pick a US stock (AAPL, NVDA, JPM, JNJ). Read trailing and forward P/E. Compare with the sector average. Cheap or expensive?