P/E Ratio (Price-to-Earnings Ratio)

P/E is the most common valuation ratio because earnings are the residual claim of shareholders. A P/E of 20 means the price is 20 times the earnings figure used in the denominator.

The ratio is only as clean as the earnings. One-time gains, a depressed profit year, or a change in share count can move P/E without any change in the business.

Compare P/E with the company's own history and with peers that have a similar growth rate, risk, and accounting quality. A higher P/E can be reasonable when earnings are expected to rise, and a low P/E can be a warning when earnings are about to fall.

Negative earnings make P/E meaningless. In that case, sales or cash-flow multiples are the usable comparisons.

Always check whether the earnings are trailing, forward, basic, or diluted. Those choices change the number. P/E also ignores the balance sheet, so a cheap earnings multiple can still sit on heavy debt.