The pricetoearnings (P/E) ratio is calculated by dividing a company’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 company’s P/E ratio based on trailing earnings to another’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. In late June, 2014, Apple was traded at $92.18 with a P/E ratio (TTM) of 15.34. On the same day, Amazon’s stock price was $334.38 with a P/E ratio of 511.06. One of the reasons Amazon’s P/E is so high is that it has been sacrificing profits in order to expand aggressively on a widescale, thus, keeping earnings suppressed and the P/E ratio very high. 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 doesn’t automatically mean a stock is undervalued, just like a high P/E ratio doesn’t necessarily mean it is overvalued.

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 is the average P/E ratio in the financial sector?
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Where can I find the P/E ratios for the Dow and S&P 500?
The most accurate P/E ratio for an index such as the S&P 500 will be found if an investor calculates the P/E ratios of all ... Read Answer >> 
What is the average pricetoearnings ratio in the insurance sector?
Learn what the average pricetoearnings ratio is for the insurance sector and why it should be used with caution. Read Answer >> 
What is the average pricetoearnings ratio in the food and beverage sector?
Learn what the average pricetoearnings ratio is in the food and beverage sector and why other measures such as median should ... Read Answer >> 
What is the average pricetoearnings ratio in the telecommunications sector?
Discover the average trailing and forward pricetoearnings ratios for the telecommunications sector and the usefulness of ... Read Answer >>

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