The P/E Ratio

Key term: P/E ratio

Once you know a company's earnings per share, a natural next question is: how much does the market charge for a dollar of that profit? That's exactly what the Price-to-Earnings ratio, or P/E ratio, measures — a company's share price divided by its earnings per share.

A high P/E generally means investors expect strong future growth and are willing to pay a premium now for earnings they expect to arrive later. A low P/E can mean a genuine bargain, or it can mean the market has real doubts about the company's future — the ratio alone doesn't tell you which.

Consider two hypothetical companies trading at the exact same $100 share price. Company A earns $10 per share, giving it a P/E of 10. Company B earns only $2 per share, giving it a P/E of 50. Despite an identical price tag, Company B is priced far more expensively relative to what it currently earns — the market is betting heavily on its future growth, while Company A looks cheap by comparison on this measure alone.

P/E comparisons only make real sense within context — comparing companies in the same sector, at similar growth stages, is far more meaningful than comparing a mature company to a fast-growing one. Used well, though, it's the single fastest way to see which of two companies the market is more optimistic about, relative to what each currently earns.

In the daily game

P/E Ratio sits in the Long Game section of every matchup's metrics panel — compare it alongside Revenue Growth to see whether a high P/E is backed by fast growth or just optimism.