Next video:
Loading the player...

Is a stock with a lower P/E always a better investment than a stock with a higher one? The short answer is no, but it depends on a few things.

The price-to-earnings ratio is a stock’s current price divided by its earnings per share. A stock trading at $40 with an EPS of $2 would have a P/E ratio of 20. So would a stock trading at $20 with an EPS of $1. With both, investors pay $20 for each dollar of earnings.

If a stock’s P/E is 40, investors pay $40 for each dollar of earnings. This seems like a bad deal, but that’s not always so.

A company with a P/E of 40 can grow revenue and earnings faster than a company with a P/E of 20, thus commanding a higher price for higher future earnings. The P/E 40 stock’s price might be based on reliable earnings estimates, while the other company’s future earnings are questionable.

P/E ratios vary among industries. Companies in stable, mature industries that have moderate growth potential usually have lower P/E ratios than companies in new, quick-growing industries with robust future potential. Investors should only compare the P/E ratios of companies from the same industry with similar characteristics.

  1. No results found.
Related Articles
  1. Investing

    Beware False Signals From the P/E Ratio

    The P/E ratio is a simple tool for evaluating a company, but it can also send false signals.
  2. Investing

    Getting On The Right Side Of The P/E Ratio Trend

    Buying at the right time is crucial, but how do we know when that is?
  3. Investing

    Comparing the P/E, EPS And Earnings Yield

    Here are three ratios that help investors value stock returns.
  4. Investing

    Differences Between Forward P/E And Trailing P/E

    The most common types of price to earnings ratios are forward P/E and trailing P/E. Find out how they differ and the advantages and drawbacks of each.
  5. Investing

    8 Blue Chip Stocks with Low P/E Ratios

    Discover why the price/earnings (P/E) ratio is important in determining the relative value of a stock and find out which S&P 500 stocks have the lowest P/E ratios.
  6. Investing

    Unlocking The P/E Ratio For Apple

    We show you how to compute and analyze the P/E ratio for Apple.
  7. Investing

    Profit With The Power Of P/E Ratio

    The P/E ratio is a valuable tool when deciding on an investment, but it's not the only thing to consider.
  8. Investing

    Stocks With Bubbles That Could Burst in 2016

    These are some of the over-valued stocks based on P/E and Forward P/E ratios. Will the bubbles burst in 2016?
  9. Investing

    The average price-to-earnings ratio in the retail sector

    Find out about the retail sector's average price-to-earnings ratio, or P/E ratio, and average P/E for companies in the seven different categories of retail.
  10. Investing

    The Netflix P/E Ratio: What You Need To Know

    We show you how to compute and analyze the P/E ratio for Netflix.
Trading Center