Understanding P/E Ratio
The P/E ratio divides a stocks price by its earnings per share. A P/E of 20 means investors are paying $20 for every $1 of earnings.
Trailing vs Forward P/E
- Trailing P/E - Uses last 12 months earnings (historical)
- Forward P/E - Uses estimated future earnings (predictive)
Forward P/E is more useful but relies on analyst estimates that may be wrong.
What Affects P/E?
- Growth rate - Faster growing companies have higher P/Es
- Risk - Riskier companies have lower P/Es
- Interest rates - Higher rates reduce P/Es
- Industry - Tech typically has higher P/Es than utilities
PEG Ratio
Divides P/E by growth rate. A PEG of 1 means the P/E equals the growth rate. PEG under 1 may indicate undervaluation; over 2 may indicate overvaluation.
When P/E Fails
P/E doesnt work well for companies with negative earnings, highly cyclical businesses, or companies with one-time charges. Use other metrics in these cases.