The pricetoearnings (P/E) ratio is calculated by dividing a companyâ€™s stock price per share by its earnings per share (EPS), giving investors an idea of whether a stock is under or overvalued. While the P/E ratio is a useful stock valuation measure, it can be misleading to investors. One reason is that a P/E ratio based on past data (as is the case with trailing P/E), does not guarantee earnings will remain the same. Likewise, if the P/E ratio is based on projected earnings (for example, with a forward P/E), there is no guarantee that estimates will be accurate. And, accounting techniques can control (or manipulate) financial reports. EPS, therefore, can be skewed, depending on how the books are done. This can make it difficult for investors to accurately value a single company or compare various companies since it may be impossible to know if they are comparing similar figures.
Another problem is that there is more than one way to calculate EPS. In the P/E ratio calculation, the stock price per share is set by the market. The EPS value, however, varies depending on the earnings data used; for example, data from the past twelve months or estimates for the coming year. Comparing one companyâ€™s P/E ratio based on trailing earnings to anotherâ€™s forward earnings creates an applestooranges comparison that can be misleading to investors. For these reasons, it is recommended that investors use more than the P/E ratio when evaluating a company or comparing various companies.
A quick look at P/E ratios for Apple Inc (AAPL) and Amazon.com Inc (AMZN) illustrates the dangers in using only the P/E ratio to evaluate a company. Apple was traded at $92.18 with a P/E ratio (TTM) of 15.34. On the same day, Amazonâ€™s stock price was $334.38 with a P/E ratio of 511.06. One of the reasons Amazonâ€™s P/E is so high is that it always reinvests its earnings. If you were to compare these two stocks based on P/E alone, it would be impossible to make a reasonable evaluation. A low P/E ratio doesnâ€™t automatically mean a stock is undervalued, just like a high P/E ratio doesnâ€™t necessarily mean it is overvalued.

How do I calculate the P/E ratio of a company?
Find out how to calculate this common valuation ratio and what the results can tell you about a company's performance. Read Answer >> 
What does the forward p/e indicate about a company?
Explore the forward price to earnings ratio and learn its significance and how it compares to the traditional price to earnings ... Read Answer >> 
What is an alternative ratio to forward p/e?
Discover the most commonly used alternative equity evaluation ratio to the forward P/E ratio, and the relative advantages ... Read Answer >> 
What is the difference between forward p/e and trailing p/e?
Understand the difference between the trailing P/E ratio, which is the standard pricetoearnings calculation, and the forward ... Read Answer >> 
What's the difference between absolute P/E ratio and relative P/E ratio?
The simple answer to this question is that absolute P/E, which is the most quoted of the two ratios, is the price of a stock ... Read Answer >> 
What is the average pricetoearnings ratio in the banking sector?
Explore the price/earnings ratio in regard to the banking industry and learn what the average P/E ratio is for most banking ... Read Answer >>

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