P/E ratio, or price-to-earnings ratio, is a quick way to see if a stock is undervalued or overvalued. And so generally speaking, the lower the P/E ratio is, the better it is for both the business and potential investors. The metric is the stock price of a company divided by itsearnings per share. You shouldn’t compare P/E ratios of different kinds of companies, like a tech company and a consumer staple company. In other words, the metric is only useful when comparing apples to apples. If you want help with using P/E ratios to invest your money, consider working with a financial advisor.
P/E Ratio: Why It’s Important
You don’t have to calculate each company’s P/E ratio yourself. After all, you can just Google it. But in case you’re curious, the ratio is the share price divided by earnings per share. The resulting number tells you how much you are paying per dollar that the company earns. Here’s the formula:
Share Price÷ Earnings Per Share = P/E Ratio
For example, a ratio of 15 would mean that investors are willing to pay $15 for every dollar of company earnings. This is why the P/E ratio is sometimes referred to as the “earnings multiple” or just “multiple.”
You generally use the P/E ratio by comparing it to other P/E ratios of companies in the same industry or to past P/E ratios of the same company. If you are comparing same-sector companies, the one with the lower P/E may be undervalued. Or if you’re looking at past data for one company, a higher number could mean it’s no longer a bargain.
How to Tell If a P/E Ratio Is Good or Bad
Ultimately, there’s no hard-and-fast rule for what a good P/E ratio is. But in general, manyvalue investorsconsider a lower P/E ratio better. Again, these ratios are often used in a comparative sense, so what’s good or bad is often dependent on what you’re comparing it against.
To give you some sense of what the average for the market is, though, many value investors would refer to 20 to 25 as the average P/E ratio range. And again, like golf, the lower the P/E ratio a company has, the better an investment the metric is saying it is.
However, the above assumes a value mindset when looking at the market. If you prefer to invest in larger, less volatile company stocks, you may be willing to pay up for a pricier investment with a higher P/E ratio.
The Drawbacks of Using P/E Ratio to Evaluate Investments
The P/E ratio seems like a straightforward calculation, but what you use for earnings can be tricky. For one thing, earnings are reported by each company, and accounting practices are not the same across the board. There’s also the possibility that a company is inflating earnings by devaluing or hiding costs.
That’s partly why it’s a good idea to take the P/E ratio with a grain of salt. Another reason: a company with a high ratio could have high growth prospects. Its ratio is high because it is spending a lot of money to grow its business. So it could still be a good buy.
In other words, you shouldn’t just zero in on the P/E ratiowhen you’re deciding whether to buy shares. There are many other metrics to consider, includingearnings charts, sales figures and other fundamentals of a company.You can also look at the dividend rate if you’re going for dividend investing. Exhaustive research should lead you to more prudent investments. If you don’t have the time, consider hiring a financial advisor.
Best P/E Ratio Stock Examples
The lower the p/e ratio, the better a stock is perceived to be for an investor because the low p/e ratio is great for the business itself. Here are six stocks with low and high p/e ratios from April 2023:
- AcelRx Pharmaceuticals, Inc. (ACRX): -0.25
- ZIM Integrated Shipping Services Ltd. (ZIM): 0.67
- Jackson Financial Inc. (JXN): 7.93
- Globus Maritime Limited (GLBS): 27.11
- Zoetis Inc. (ZTS): 37.00
- The Walt Disney Company (DIS): 73.40
Bottom Line
It’s a good idea for investors to understand the P/E ratio and how to use it to evaluate share prices. But it’s only one of many available metrics. It shouldn’t be used alone, and it shouldn’t be used to compare companies that are in different businesses. That said, it is a handy way of seeing if a stock is a bargain or not. You can use it to find the right investments for your portfolio.
Tips to Become a Better Investor
- Financial advisors often have years of experience managing investments, making them great partners for anyone looking to improve their portfolio. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Exchange-traded funds, or ETFs, can be a great way to quickly flesh out your existing portfolio. Like mutual funds, ETFs are baskets of stocks that carry less overall risk than an individual company’s stock does. But unlike mutual funds, you can trade ETFs very easily, buying or selling them very quickly.
- If you’re unsure about how much money an investment could make, SmartAsset’s free investment calculator could help you get an estimate.
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FAQs
Many investors say buying shares in companies with a lower P/E ratio is better because you are paying less for every dollar of earnings. A lower P/E ratio is like a lower price tag, making it attractive to investors looking for a bargain.
Is a higher or lower PE ratio better? ›
If the share price falls much faster than earnings, the PE ratio becomes low. A high PE ratio means that a stock is expensive and its price may fall in the future. A low PE ratio means that a stock is cheap and its price may rise in the future. The PE ratio, therefore, is very useful in making investment decisions.
What is considered a good P/E ratio? ›
Typically, the average P/E ratio is around 20 to 25. Anything below that would be considered a good price-to-earnings ratio, whereas anything above that would be a worse P/E ratio.
Is 7 a good PE ratio? ›
To give you some sense of what the average for the market is, though, many value investors would refer to 20 to 25 as the average P/E ratio range. And again, like golf, the lower the P/E ratio a company has, the better an investment the metric is saying it is.
Is 30 a good PE ratio? ›
A P/E of 30 is high by historical stock market standards. This type of valuation is usually placed on only the fastest-growing companies by investors in the company's early stages of growth. Once a company becomes more mature, it will grow more slowly and the P/E tends to decline.
Is a PE ratio of 17 good or bad? ›
Why is 17 used to calculate PE? The Price to Earnings ratio is to give you an idea of where a company is valued versus the rest of the market AND compared to other companies in the same sector. In general, the market is historically considered fairly valued when in the 15–17 range.
Is a PE ratio of 40 good? ›
A high P/E ratio, above 40, indicates investors willing to buy a stock at 40 times or more its earnings. Whether investing at a high PE ratio is good or bad depends on various factors.
Is 0.5 a good PE ratio? ›
The ratio is calculated by dividing the price-earnings ratio by the sum of the earnings growth rate and the dividend yield. With this modified technique, ratios above one are considered poor, while ratios below 0.5 are considered attractive.
Can a PE ratio be too high? ›
That is, the P/E ratio shows what the market is willing to pay today for a stock based on its past or future earnings. A high P/E ratio could signal that a stock's price is high relative to earnings and is overvalued. Conversely, a low P/E could indicate that the stock price is low relative to earnings.
Is a 200 PE ratio good? ›
A P/E ratio of 200 is high. But it is basically saying that people expect the company to grow earnings to be 15 to 20 times as large as they are now (so the P/E ratio would be 10 to 15). If you don't think that the company has that kind of potential, don't invest.
P/E ratio as of May 2024 (TTM): 52.8
According to Tesla's latest financial reports and stock price the company's current price-to-earnings ratio (TTM) is 52.783. At the end of 2022 the company had a P/E ratio of 30.6.
Is a 50 PE ratio good? ›
If a stock's price rises, you need to pay close attention when a stock gets bid up to an excessively high P/E level. In the heat of a bull market, it's not uncommon to find "hot" stocks trading at a P/E of 50 or more. While this can go on for some time, eventually the stock's price may drop.
Is 8 a high PE ratio? ›
Although eight is a lower P/E, and thus technically a more attractive valuation, it's also likely that this company is facing financial difficulties leading to the lower EPS and the low $2 stock price. Conversely, a high P/E ratio could mean a company's stock price is overvalued.
What stock has the best P/E ratio? ›
Stocks with the Highest PE Ratios
- Pidilite Inds. Adhesives Manufacturing.
- ITI. Telecom.
- Chandra Bhagat. Pharmaceutical.
- Active Clothing. Integrated Apparel Manufacturing.
- Kemp & Co. Pharmaceutical.
- Natl. Peroxide. ...
- Ethos Ltd. Luxury and Premium Watch Retail.
- Hind Rectifiers. Electrical Equipment Manufacturing.
Stocks with high price-to-earnings (P/E) ratios can be overpriced. So, is a stock with a lower P/E ratio always a better investment than a stock with a higher one? The short answer is no. The long answer is that it depends on the situation.
What does PE ratio tell you? ›
The P/E ratio is calculated by dividing the market value price per share by the company's earnings per share. A high P/E ratio can mean that a stock's price is high relative to earnings and possibly overvalued. A low P/E ratio might indicate that the current stock price is low relative to earnings.
Is a higher PE ratio more risky? ›
Price Earnings (P/E) ratio is one of the most popular ways of valuing a stock. The thumb rule is that a low P/E ratio is a sign of undervaluation while a high P/E ratio is a sign of overvaluation. But such an approach of purely using P/E Ratio to Value a stock is fraught with risks.
What is a good earnings per share ratio? ›
There is no hard and fast number to define a good EPS across companies. Since so many factors go into a company's net income and stock price, variables always exist from one company to the next. To determine whether a company's EPS is "good," it's essential to consider the company's earnings per share in context.
Is a negative P/E ratio good or bad? ›
A high P/E might indicate that investors expect earnings growth in the coming quarters and, as a result, investors have been buying the stock in anticipation of its appreciation. A negative P/E ratio means the company has negative earnings or is losing money.
What is a good PE ratio for banks? ›
Well, the banking sector as a whole had a P/E ratio of approximately 13.50 and compares with an overall market average P/E ratio of 36.7. 4 However, this is a simple arithmetic average of P/E ratios is skewed by the figures for a very small number of firms with P/E ratios over 100 or 200.
