The price-to-earnings (P/E) ratio is one of the most widely used tools that investors and analysts use to determine a stock’s valuation. The P/E ratio is one indicator of whether a stock is overvalued or undervalued. Also, a company’s P/E ratio can be benchmarked against other stocks in the same industry or the .

The P/E ratio measures the market value of a stock compared to the company’s earnings. The P/E ratio reflects what the market is willing to pay today for a stock based on its past or future earnings. However, the P/E ratio can mislead investors, because past earnings do not guarantee future earnings will be the same. Likewise, projected earnings may not come to fruition.

### Key Takeaways

- The price-to-earnings (P/E) ratio measures a company’s market price compared to its earnings. It shows what the market is willing to pay today for a stock based on a company’s past or future earnings.
- A company’s P/E ratio can be benchmarked against other stocks in the same industry or the S&P 500 Index.
- This helps show whether a stock is overvalued or undervalued.

## Components of the P/E Ratio

### Market Price

- The prevailing market price of a stock represents the “P” in P/E ratio.
- Stock price is determined by supply and demand in the market.

### Earnings per Share

- Earnings per share (EPS) is the amount of profit allocated to each share of a company’scommonstock. EPS is the portion of net income that would be earned per share if all profits were distributed to shareholders.Analysts and investors use EPS to establish a company’s financial strength.
- EPS represents the “E” in P/E ratio, whereEPS = earnings ÷ total shares outstanding.
- As long as a company has positive earnings, the P/E ratio can becalculated. Acompany thatis losing money has no P/E ratio.
- EPS is often taken from a company’s last four quarters of financial results, or the trailing 12 months (TTM), and is called thetrailing EPS. However, EPScan also be taken from future earnings forecast over the coming four quarters, which is called theforward EPS.

As a result, a company will have more than one P/E ratio, so investors must be careful to compare the same P/E when evaluating and comparing different stocks.

No single ratio will tell an investor everything they need to know about a stock. Investors should use a variety of financial ratios to assess the value of a stock.

## Calculating the P/E Ratio

To calculate a company’s P/E ratio, we use the following formula:

$\text{P/E Ratio}=\frac{\text{Price per Share}}{\text{Earnings per Share}}$P/ERatio=EarningsperSharePriceperShare

## Example of the P/E Ratio: Comparing Bank of America and JPMorgan Chase

Bank of America Corp. (BAC) closed 2017 withthe following:

**Stock Price**= $29.52**Diluted EPS**= $1.56**P/E**= 18.92 or $29.52 ÷ $1.56

In other words, Bank of Americatraded at roughly 19× trailingearnings. However, the 18.92 P/E multipleby itself isn’t helpful unless you have something to compare it with, such as the stock’s industry group, a benchmark index, or Bank of America’s historical P/E range.

Bank of America’s P/E at 19× was slightly higher than the S&P 500, which over time trades at about 15× trailingearnings.

To compare Bank of America’s P/E to a peer, we calculate the P/E for JPMorgan Chase & Co. (JPM) as of the end of 2017.

**Stock Price**= $106.94**Diluted EPS**= $6.31**P/E**= 16.94

When you compare Bank of America’s P/E of almost 19× to JPMorgan’s P/E of roughly 17×, Bank of America stock does not appear as overvalued as it did when compared with the averageP/E of 15 for theS&P 500. Bank of America’s higherP/E ratio might mean investorsexpected higher earnings growth in the future compared toJPMorganand the overall market.

However, no single ratio can tell you all you need to know about a stock. Before investing, it is wise to use a variety of financial ratios to determine whether a stock is fairly valued and whether a company’s financial health justifiesits stock valuation.

## How Do You Benchmark a Company’s Price-to-Earnings (P/E) Ratio?

A company’s P/E ratio can be benchmarked against other stocks in the same industry or the S&P 500 Index. It helps show whether a stock is overvalued or undervalued.

## What Is a P/E Ratio Composed of?

The parts of a P/E ratio are:

- Market price (the “P” in P/E ratio)
- Earnings per share (the “E” in P/E ratio)

## How Do You Calculate a P/E Ratio?

Divide a company’s price per share by earnings per share (EPS), and the result is the P/E ratio.

## The Bottom Line

A company’s price-to-earnings (P/E) ratio measures that company’s market price compared to its earnings. It shows what the market is willing to pay today for a stock based on the company’s past or future earnings.