What is the P/E Ratio?

The formula and a worked example

P/E = Share Price ÷ Earnings Per Share (EPS), where EPS is a company's annual profit divided by its total shares on issue. Take a fictional company, Koala Corp: a share price of $20 and EPS of $2 gives a P/E of $20 ÷ $2, or 10 times. That means investors are paying $10 for every $1 of Koala Corp's annual profit.

Trailing vs forward P/E

Trailing P/E uses actual reported earnings from the past 12 months, backward-looking and factual. Forward P/E uses analyst forecasts for the next 12 months, more relevant for a growth story but only as reliable as those forecasts turn out to be. Use trailing P/E for grounded, apples-to-apples comparisons, and treat forward P/E with a healthy dose of scepticism for companies in a growth phase. Most data platforms, including Market Index, show trailing P/E by default.

What a high or low P/E actually signals

There's no universal good or bad P/E, it's always context-dependent. A high P/E can mean the market expects strong future earnings growth, common for growth stocks, or it can simply mean the stock is overvalued. A low P/E can mean a genuine bargain, or it can mean the business is struggling and declining earnings are already priced in. The most useful comparison is against the same company's own historical average, its sector peers, or a relevant index benchmark, rather than the market as a whole.

Australian benchmarks (approximate, August 2026)

The ASX 200's long-run average P/E sits around 15 to 16 times, though it has recently traded closer to 21 times, above its historical norm. Sector averages vary enormously: Information Technology has traded around 41 times, reflecting high growth expectations, Financials and the major banks around 15 to 18 times as mature dividend payers, and Materials and Resources around 13 to 14 times, cyclical and commodity-price dependent. Those gaps mean a tech stock on 41 times isn't automatically overpriced, and a miner on 13 times isn't automatically cheap, always check the sector average before judging a number on its own.

Where P/E falls short

It doesn't work for loss-making companies, negative EPS makes the ratio meaningless or negative, common for early-stage tech or biotech businesses that need other metrics entirely. It ignores debt, a heavily leveraged company can look cheap on P/E while carrying real risk, which is why metrics like EV/EBITDA are often more useful there. Cross-industry comparisons can also mislead, comparing a bank's P/E to a software company's is a bit like comparing rental yield to a startup's revenue multiple, stick to within-sector comparisons. And earnings themselves can be shaped by legitimate accounting choices, like depreciation method or the timing of revenue recognition, or one-off write-downs, so it's worth cross-checking P/E against cash flow rather than taking reported EPS at face value.

Three common misconceptions

• A low P/E isn't always a bargain. It can be a "value trap" if the business is in structural decline with earnings that keep falling.
• A high P/E isn't always overvalued. It can be entirely rational if the growth rate justifies the premium, 30% earnings growth can reasonably command a high multiple. The PEG ratio, P/E divided by the expected earnings growth rate, helps account for this.
• P/E doesn't work for every company. It doesn't apply to loss-makers or very early-stage businesses, revenue multiples or price-to-book are more useful there instead.