What is a good P/E ratio?

It depends on what you compare it with. A P/E means something only against the company's own past range and against similar businesses, and companies with steadier or faster-growing earnings usually trade at higher multiples. A low P/E can also be a sign that the market expects earnings to fall.

Can a P/E ratio be negative?

Mathematically, yes: a company with negative earnings per share produces a negative result, and that number has no useful reading, so quote screens often show it as blank. For a company losing money, price-to-sales, which is market capitalization divided by a year of revenue, gives a figure you can compare.

Is forward P/E more reliable than trailing P/E?

Trailing P/E rests on the last four reported quarters, which you can check in the filings. Forward P/E rests on analyst estimates for the coming year, which get revised. The forward figure shows what the market expects, and the trailing one is firmer ground for a first check.

P/E Ratio: Price Against Earnings, Your First Valuation Check

You have two numbers in front of you now. The share price is on your screen. Earnings per share sits at the bottom of the income statement you read in the previous lesson. Divide the first by the second.

The P/E ratio

The ratio is the price of one dollar of annual profit.

A P/E of 20 means buyers are paying twenty years’ worth of current profit. That sounds like a lot. It isn’t a verdict, though, because nobody expects profit to stay exactly where it is, and a company that can grow its earnings steadily is worth more per dollar of today’s profit than one that can’t.

Run the company-wide version at least once, because it shows the ratio comes out the same whether you think in single shares or in the whole business, and because market capitalization and net income are the figures you’ll quote when you write your case in the last lesson.

Earnings yield: the same number upside down

Flip the fraction and you get the earnings yield.

A 5% earnings yield means each $100 of stock carries $5 of annual profit. Most of that profit won’t reach you as cash, since the board decides what to pay out, but the percentage makes it easy to compare a stock with other things you could own. Some investors find it more intuitive than the P/E. Use whichever reads more clearly to you.

Trailing and forward P/E

Quote screens often show two P/E figures, and they can differ a lot.

A trailing P/E divides the current price by earnings per share over the last four reported quarters. Those earnings have happened. You can check every one of them in the company’s filings on EDGAR.

A forward P/E divides the price by what analysts estimate the company will earn over the coming year, and since estimates are forecasts that get revised, sometimes sharply after a quarterly report, the forward figure is only as good as the guess behind it. Where earnings estimates come from explains how those forecasts are built. When forward P/E sits well below trailing P/E, the market expects earnings to rise. Ask whether you believe it.

For a first check, start with the trailing figure. It’s built from reported numbers.

What to compare it with

A P/E means little on its own. Twenty could be cheap for one business and dear for another. You need two comparisons.

The first is the company’s own history. Work out the P/E at a few past points using the price then and the trailing earnings then, which you can take from older 10-K filings. If the stock has usually traded between 15 and 20 times earnings and now sits at 30, something has changed. Maybe the business improved. Maybe the market got excited. Your job is to find out which.

The second is similar companies. Take a handful of businesses that sell comparable things to comparable customers, look up their trailing P/Es, and see where yours falls; a retailer belongs next to other retailers, and setting it beside a software company tells you nothing, since the two earn money in such different ways that their normal P/E ranges have little to do with each other.

When earnings are negative

A company that lost money has negative earnings per share. Divide a positive price by a negative number and you get a negative P/E, which has no sensible reading. Many quote screens leave it blank or show “N/M” for not meaningful.

Switch to a sales-based measure. Price-to-sales divides market capitalization by a year of revenue, and revenue stays positive even when the company is losing money.

The same rule applies: compare it with the company’s history and with similar businesses. A low price-to-sales ratio on a company that never turns sales into profit isn’t a bargain.

Run the trailing P/E and earnings yield for your own company now. Write both beside the market capitalization from lesson one. The growth course takes valuation further, and the last lesson here turns everything you’ve gathered so far into a one-page written case for or against buying the stock.