P/E ratio explained: formula, examples and limitations

The price-to-earnings ratio, or P/E, compares a share’s market price with its earnings per share. It expresses how much the market price represents for each unit of annual earnings. It is usually written as a multiple, such as 15×.

Calculate a simple example

A fictional share trades at £24 and has annual earnings per share of £2. Its P/E is 12×. If its share price rises to £30 while earnings stay at £2, the ratio becomes 15×. The higher multiple reflects the price change, not an improvement in the earnings figure.

Try the reverse: keep the price at £24 but reduce earnings to £1.50. P/E becomes 16×. A multiple can therefore rise because earnings deteriorate, even when the share price does not move.

Trailing versus forward P/E

A trailing ratio generally uses a past earnings period; a forward ratio uses an earnings forecast. State which you are using. Forecast earnings are uncertain, and different estimates may produce different forward multiples for the same share price.

Does a low P/E mean a cheap share?

Not necessarily. Imagine two companies both earning £2 per share. One trades at £16, the other at £30. Their ratios are 8× and 15×, but the figures alone do not tell you which is better value. Different growth prospects, debt levels, risks or unusual earnings could explain the gap.

When the ratio stops being useful

If earnings are zero, division is undefined. With negative earnings, a conventional positive P/E comparison is not meaningful. Our calculator therefore requires positive earnings per share. It also cannot judge whether the reported earnings are sustainable.

Build a fair comparison

Use the same earnings period and a consistent earnings definition. Check whether the figure is basic or diluted, reported or adjusted, and whether the share price is quoted in pounds or pence. A £20 share price divided by earnings of 100 pence must use £1 in the denominator, giving 20×.

Use the result as a starting question about valuation. Follow it with a reading of the company’s results, cash generation and financing, rather than a trading rule.