What P/E Ratio Tells You About a Stock

In an episode of Billions, the TV drama which delves into the New York hedge-fund world, billionaire hedge fund owner Bobby Axelrod compares sports to investing. He says that he began to really understand what happens on a sports field by taking his eyes away from it and instead analyzing "the underlying numbers." Sometimes, digging into the data, whether in sports performance or investing, can help fuel success.

On the Investing Side...

Strong research can help foster a solid investment strategy. Research, in part, can come from careful analysis of "the underlying numbers" to do with the assets under consideration for your portfolio. When it comes to stocks, there are many measures that can be looked at when evaluating whether an investment is right for you. One (again, just one of the many!) number-crunching concepts that investors often take into consideration when making investment decisions is the price-to-earnings, or P/E, ratio. Here's how it plays out...

P/E Play-by-Play

Considered one of the most common measures for looking at stocks, the P/E ratio evaluates the relationship between a company's stock price and its earnings. In simple terms, it's often considered a measure of how over- or undervalued a company's stock is. A common way to calculate the P/E ratio, called trailing price-to-earnings, takes a company's current per-share price and divides it by its "trailing" per-share earnings. The "trailing" refers to average per-share earnings for the previous four quarters, which is also known as TTM, or trailing 12 months. For example, if shares are trading at $30 each, and average earnings were $5 per share, the P/E would be 6 ($30/$5=6). The trailing P/E ratio is broken out in the overview tab of a detailed quote page and under the fundamentals tab.

Another way to look at the per-share portion of the P/E ratio is by using expected, or forecasted, share earnings for a company, which results in a forward P/E ratio. The calculation is similar, using a company's current per-share price but dividing it by analyst expectations for earnings going forward. Earnings and estimate ranges can be found under the Research tab of a detailed quote page.

The higher a P/E ratio, in theory, means that investors may be anticipating higher growth in the future and could be willing to pay more per share. On the other hand, a low P/E might mean that a stock is undervalued or that markets expect little earnings growth.

Check the Competition

Like ranking a sports team based on its competition, a P/E ratio is more helpful when there's something to compare it with. While there are limitations to each, some useful benchmarks can include:

• P/E ratios of other companies in the same industry (think of it as apples to apples)
• Overall market P/E ratio (such as the S&P 500)
• The company's P/E ratio at various points in its history (detailed quotes can offer this)

P/E is an important analytical ratio when considering a stock, but it's only one measure that can help support investment decisions. Information on the fundamentals tab of a detailed quote can allow you to undertake additional analysis, such as reviewing return on equity and price-to-book ratios. The financials offers access to income statements, balance sheets and cash flow statements for further research options.

In sports and investing, careful analysis of a range of data, trends and numbers produces a more rounded picture, helping both coaches and investors make the most informed decisions they can. The Research tab can help you create your own playbook for your research and investing goals based on your personal risk profile.

*This article was last updated in September 2021 to clarify an incorrect calculation.