What is a normal P/E ratio?

It varies significantly by sector, growth rate and interest rate environment. Defensive sectors like consumer staples often trade at lower multiples. Growth companies can have very high P/E ratios if the market believes in future earnings increases. There is no universally normal P/E.

What is the difference between P/E and forward P/E?

Standard P/E is calculated on the last twelve months of actual earnings. Forward P/E is based on analysts' forecasts for the next twelve months. Forward P/E can be more relevant but depends on the accuracy of those forecasts.

What is the PEG ratio?

PEG is P/E divided by expected earnings growth. It adjusts the P/E for growth. A company with a P/E of 30 and 30 per cent growth has a PEG of 1, which may be more attractive than a company with P/E of 15 and 5 per cent growth (PEG of 3). It is a tool for avoiding paying too little for growth or too much for stagnation.

Glossary

P/E Ratio

The share price divided by earnings per share. One of the most common valuation metrics, and also one of the most misunderstood.

What it is

The price you pay for one unit of earnings

The P/E ratio, or Price-to-Earnings ratio, measures how many units of currency you pay per unit of a company's earnings. A P/E of 20 means you pay 20 for every 1 in annual earnings. It is the most common valuation metric in equity markets. But it says nothing about whether the earnings are sustainable, whether they are representative of the company's true earning power, or whether growth justifies the price. That is why P/E is a starting point, never a conclusion.

Interpreting P/E: A high P/E can mean the market expects strong growth. A low P/E can signal a bargain, or that the market has spotted problems not immediately visible in the numbers. Context is everything.
P/E and interest rates: P/E multiples tend to expand when interest rates are low, because the opportunity cost of capital is lower. Conversely, P/E compresses when rates rise and investors can earn returns with less risk.
Normalised P/E: Working with normalised earnings rather than reported earnings of any single year gives a more accurate P/E. One-off items, cyclicality and accounting choices can make annual earnings misleading.

In practice

P/E as a question, not an answer

P/E is useful, but never the only metric to consider. What matters more is what the earnings represent. Is the margin normal? Is growth driven by the operating business or by one-off items? Can the company sustain and grow its earnings? A premium valuation is justified if the company consistently delivers. A low valuation is not a bargain if the business model is deteriorating.

“We separate the company from the stock.”

Amos Fonder

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Common questions about P/E ratios

Related concepts

Glossary

CAGR

Compound Annual Growth Rate. The annual growth rate that would have taken a value from point A to point B, as if growth had been perfectly smooth every year.

DCF

Discounted Cash Flow. A valuation method that calculates what a company's future cash flows are worth today. The core principle: a unit of money tomorrow is worth less than a unit of money today.

ROIC

The single metric that best measures whether a company is genuinely creating value with its capital — or merely cycling through it.

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