Price-to-Earnings ratio explained: What it is and how to use it Saxo Bank Switzerland

The EV/EBITDA ratio is helpful because it accounts for the company’s debt and cash levels, providing a more holistic view of its valuation compared to the P/E ratio. It assesses a company’s valuation relative to its earnings before interest, taxes, depreciation, and amortization (EBITDA). This ratio is what are audit assertions and why they are important useful for evaluating companies that may not be profitable yet or are in industries with volatile earnings. Thus, it’s possible it could be manipulated, so analysts and investors have to trust the company’s officers to provide genuine information. A main limitation of using P/E ratios is for comparing the P/E ratios of companies from varied sectors.

Charlotte’s price-to-rent ratio of 23 arises from a median home sale price of $400,000 and median annual rent of $17,160. This east coast Florida city had a recent ratio of 22, based on a median sale price of $312,000 and median rent of $15,040 per year. This major Sunshine State city has a price-to-rent ratio of 23, based on a median home sale price of $450,000 and median annual rent of $19,320. The ratio here has nearly reached 20, based on a median home sale price of $376,000 and median rent of $19,200 per year.

The reality is that the PE ratio is not a great basis for investment decisions because there is simply no magic number to which the ratio tends to revert.” “In the last 20 years, for example, the S&P 500 has seen PE ratios as low as 13 and as high as 123. Discerning between undervalued stocks and potentially troublesome stocks also requires further analysis.

• This is a high PE ratio, but it may make sense because of Microsoft’s earnings growth rate and promising future prospects.
• A low PE ratio may signal that the stock price doesn’t accurately reflect the true value of the company based on its earnings.
• Is the high PE ratio a symptom of market-driven hype?
• Detroit has seen a consistent rise in home sale prices, though the latest median sale price was a relatively low $97,200, compared with median annual rent of $12,600.
• It shows how much investors are willing to spend for each dollar of the company’s profit.
• Knowing where the market stands can help you avoid overpaying during a bubble.

The value depends on all expected future cash flows and earnings of a company. If the P/E is lower than the justified P/E ratio, the company is undervalued, and purchasing the stock will result in profits if the alpha is closed. In other words, the two ratios should produce two different results. And when it does, investors make a profit as a result of a higher stock price. The mispricing will be a great bargain and will prompt investors to buy the stock before the market corrects it.

The price-to-earnings ratio meaning isn’t difficult to understand. Although the PE ratio is useful to get a quick idea of a company’s valuation, it is still just one part of a complicated puzzle. Investing based on the PE ratio alone is a bad idea because cheap stocks are often cheap for a good reason.

Negative P/E ratio

The real art lies in how to use the Price to Earnings ratio effectively. Ready to put the P/E ratio to work in your investing? Think of it as a barometer of market sentiment and expectations. He is a long-time active investor and engages in research on emerging markets like cryptocurrency.

For example, a stock with a relatively high 12-month trailing P/E ratio could lead you to believe that the shares are overvalued. While both measure a company’s share price relative to its profits, it’s important to note that they can sometimes tell different stories. So, for example, if the share price of a company is $50 and its EPS is $5, the P/E ratio would be 10. It can help you determine if a stock’s market price is fair relative to the profits the company produces.

Is a negative PE ratio good or bad?

•   A ratio of 16 to 20 indicates that it’s typically better to rent than buy. •   A ratio of 1 to 15 typically indicates that it’s more favorable to buy than rent in a given community. InvestingPro offers a comprehensive suite of financial models, fair value estimates, and analyst targets to complement your analysis of operational efficiency. It is the necessary metric for making sense of high-growth technology, speculative biotechnology, or any company poised for a major inflection point.

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Investors calculate the P/E ratio of a company so that they can compare the value of one stock in a sector with another. Small-cap stocks are generally considered riskier and more prone to wide market fluctuations than large-cap stocks. S&P 500 Index is a stock market index tracking the stock performance of 500 of the largest companies listed on stock exchanges in different types of bookkeeping accounts and their specifics the U.S. Benchmarks and financial indices referenced herein are representative of large and small domestic and international stocks and bonds, each with unique risks. No assurance can be given as to actual future market results or the results of Wilmington Trust’s investment products and strategies.

What Are Meme Stocks and Are They Worth the Investment?

• Analyst predictions can be wrong, and sometimes companies themselves provide guidance that turns out to be way too optimistic or pessimistic.
• With $5 million in earnings and 400,000 outstanding shares, Company Y has an EPS of $12.50 (5,000,000/400,000).
• The PE ratio is very popular because it is easy to understand and easy to calculate.
• However, including the company’s growth rate to get its PEG ratio might tell a different story.
• Earnings can fluctuate due to market cycles, accounting decisions, or extraordinary items.
• P/E ratios help to define stocks as either growth or value investments.
• Companies’ valuation and growth rates often vary wildly between industries because of how and when the firms earn their money.

The U.S.’s rising mountain of government debt poses big challenges to the economy and the markets. The U.S. push to bring manufacturing back home through tariffs could undo decades of global economic integration. By understanding these experiments, we can identify areas of potential growth and position portfolios to capture value—while managing risk—to help you navigate the year ahead. Join us on 1/14 at 12PM ET as our investment team discusses their 2026 outlook to help shape your strategy for the year ahead. Who knows, you might even happen on just what you wanted at an accessible price.

At the same time, the predictions of future growth are only estimates and could very well be flawed. I’d also encourage new investors to practice first by making trades using a paper trading account. If you’re new to investing, there’s no better way to get started than by checking out our guide to the best stock trading platforms for beginners. Investors want to know how profitable a company is right now and how profitable it might be in the future. That said, there are many variations, alternatives, and factors that must be taken into consideration when interpreting this ratio and using it to evaluate a stock.

How to Calculate Price-to-Rent Ratio

It is calculated by dividing the current share price by the earnings per share over the past 12 months (TTM). Some analysts believe that stocks with relatively low P/E ratios present buying opportunities, allowing investors to purchase an undervalued stock that still has strong earnings. If the current P/E ratio of a company is high relative to its past P/E ratio or compared to similar companies, it could be an indication that the stock is overvalued. But the price to earnings ratio is a helpful tool available for all investors when analyzing stocks. However, the price to earnings ratio alone does not tell investors everything they need to know about a stock and whether it is a sound investment.

This suggests that the market is strongly overvalued compared to its historical norms. For instance, the S&P 500’s 10-year P/E ratio stood at 37.1 as of November 2025, which is 80.9% above its modern-era average. Knowing where the market stands can help you avoid overpaying during a bubble.

With a median home price of $855,000 and one-bedroom rent averaging $1,850 a month, Long Beach earned a ratio of 39. A median sale price of $1,010,000 and a median one-bedroom rent of $28,800 a year ($2,400 a month) shines a Hollywood light on renting, with a rent-to-price ratio of 35. Meanwhile, the median annual rent for a one-bedroom was $23,400, for a price-to-rent ratio of around 36. The median sale price here was $1,455,000, and the city had a median one-bedroom rent of $32,640 annually ($2,720 a month), leading to a price-to-rent ratio of 45.

A PEG below 1 might signal that the stock is a bargain relative to its growth prospects, while a PEG well above 1 could mean it’s overvalued. These additional ratios help answer questions the P/E simply can’t. While the P/E ratio is a cornerstone of valuation, relying on it alone is like a carpenter trying to build a house with just a hammer. For example, stacking up a capital-intensive utility company against a high-growth software firm is a classic apples-to-oranges mistake. Even when a company has positive earnings, the “E” in the P/E isn’t always as clean as it looks.

When distinguishing absolute P/E from relative P/E, remember that absolute P/E represents the P/E of the current period. Analysts also distinguish between absolute P/E and relative P/E ratios in their analyses. For example, a low P/E ratio could suggest a stock is undervalued and worth buying. If a company has negative earnings, however, it would have a negative earnings yield, which can be used for comparison. The earnings yield is also helpful when a company has zero or negative earnings.

Any investment decision or strategy employed by investors—whether based on or independent of material accessed through this website—is undertaken at their sole discretion and risk. Each DIY Vest is created by individual users of this website, and Vested Group does not play any role in the selection of stocks for DIY Vests. Investments in stocks and Exchange-Traded Funds (ETFs) may decline in value. A copy of Vested Finance Inc.’s current written disclosure brochure, filed with the SEC, discusses, among other things, its business practices, services, and fees. Registration as an investment adviser does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Commission. The P/E ratio ignores debt, cash flow quality, growth sustainability, and accounting differences.

Saxo partners with companies that provide compensation for promotional activities conducted on its platform. Mentions of specific financial products are for illustrative purposes only and may serve to clarify financial literacy topics. Saxo Bank A/S and its entities within the Saxo Bank Group provide execution-only services, with all trades and investments based on self-directed decisions. Why reinvesting dividends is essential for compounding growth It’s essential to look deeper, understand what is driving the numbers, and consider other metrics like the PEG ratio for a more complete assessment.

The P/E ratio also helps investors determine a stock’s market value compared with the company’s earnings. A price-to-earnings ratio doesn’t mean much until you compare it to the rest of the stocks in the same sector, or other companies listed on the same index. The price-to-earnings ratio can also be used as a guide to determine whether a company is currently over- or undervalued compared with its historical averages. This quick, forward-looking comparison helps you determine which company has the more appealing future path priced into its current stock value.