What P/E is in plain words: how to tell whether a stock is expensive
P/E shows how many dollars an investor pays for one dollar of a company's annual profit. It is the quickest way to tell whether a stock is expensive.
- P/E is how many dollars are paid for one dollar of a company's annual profit.
- Up to 15 is inexpensive, 15–25 ordinary, above 25 expensive; compare only within an industry.
- A low P/E can be a trap, a high one the price of fast growth.
How it is calculated
P/E = share price ÷ earnings per share for the year.
A share costs $100 and the company earned $5 per share — P/E is 20. In other words: if profit stays the same, the company “pays back” its price in twenty years.
You get the same number by dividing the whole company's value by its annual profit.
Which value counts as normal
| P/E | What it usually means |
|---|---|
| Up to 15 | Inexpensive: the market expects no fast growth |
| 15–25 | An ordinary level for a sturdy business |
| Above 25 | Expensive: years of profit growth are priced in |
| No value | The company has a loss — nothing to divide by |
These are reference points. The average P/E of the US market over its long history is about 15–20; in recent years it has been higher.
Why a high P/E is not always bad
If a company's profit doubles every three years, today's P/E of 40 becomes 20 in three years at the same price. The market pays for fast growth in advance.
The risk lies elsewhere: if growth slows, the price falls sharply — both the profit and what people will pay for it shrink.
Why a low P/E is not always good
A stock can be cheap for a reason: the business is shrinking, the profit was a one-off, the company has heavy debt or legal trouble. This is called a “value trap”: a P/E of 6 looks like a gift, and a year later there is no profit at all.
What to compare it with
- Companies in the same industry. Banks and oil companies usually have a low P/E, software makers a high one. Comparing them with each other is pointless.
- The company's own history. If it traded at 20 times earnings for five years and now at 35, something changed: the business or the expectations.
- Profit growth. A P/E of 30 with 30% growth a year and a P/E of 30 with 3% growth are very different stories.
What P/E does not show
- Debt: two firms with the same P/E can owe very different amounts.
- The quality of profit: it can be dressed up by accounting — see the course “Accounting for investors”.
- The future: the calculation uses last year's profit.
So P/E is a first look, not a decision. The other four metrics are in the guide “How to pick a stock”.
Any company's P/E by year over 20 years, next to growth, margin and debt.
Analyse a company →Pages of 800 companies: growth, profit, debt and price of each.
All companies →This article is educational and is not investment advice. The thresholds are reference points, not rules.