Earnings Multiples: P/E and PEG

Why this matters

"This stock trades at 30 times earnings" is one of the most common things said about a company's valuation. The price-to-earnings ratio is quick to calculate and easy to compare, which is why it's everywhere. It's also easy to misread. This lesson covers what it measures, its forward-looking cousins, and its blind spots.

The P/E ratio

P/E ratio = Share price ÷ Earnings per share

The SEC's guide gives a simple example: a stock priced at $20 with earnings of $2 per share has a P/E of 10, meaning it trades at ten times earnings.¹ The P/E ratio tells you how many dollars investors are paying for each dollar of the company's yearly profit.

• Trailing P/E uses actual earnings from the last year, or the last four quarters.
• Forward P/E uses analysts' estimates for the next year, which are forecasts and can be wrong.

STU Corp's shares trade at $50. Suppose analysts expect earnings per share of $3.25 next year, about 12% more than this year's $2.90. The estimate is hypothetical.

Measure	Calculation	Result
Trailing P/E	$50 ÷ $2.90	17.2
Forward P/E	$50 ÷ $3.25	15.4
PEG ratio	17.2 ÷ 12	1.4

Investors are paying about $17 for each dollar of STU Corp's current yearly earnings. For context, NYU Stern professor Aswath Damodaran's January 2026 data shows US household products companies with a combined market value of about 24 times their combined net income.² STU Corp looks cheaper than that group. Whether that's a bargain or a fair discount for its risks is the question the rest of this module helps answer.

Why P/E ratios differ

A P/E ratio bundles the market's expectations into one number. Higher ratios usually reflect:

• Faster expected growth: investors pay more today for earnings expected to rise.
• Lower risk: steadier, more predictable earnings are worth more.
• Lower interest rates: when safe investments pay less, future earnings are worth more today, a link the last module of this part explains.

Adding growth: the PEG ratio

PEG ratio = P/E ratio ÷ Expected yearly earnings growth rate, in percent

The PEG ratio tries to compare a slow grower and a fast grower on equal terms. A company with a P/E of 30 growing 30% a year has a PEG of 1; one with a P/E of 15 growing 5% a year has a PEG of 3. By this measure, the first is cheaper relative to its growth. Some investors treat a PEG near 1 as reasonable, but it's a crude tool: the growth rate is an estimate, and it ignores how long the growth will last and how risky it is.

When P/E misleads

• Losses. With negative earnings, P/E is meaningless.
• One-time items. A one-off gain makes P/E look low; a one-off charge makes it look high. Check what's in the earnings, as GAAP and Non-GAAP Numbers explained.
• Cyclical peaks. For businesses like steel or airlines, earnings swing with the economy. P/E often looks lowest at the peak of the cycle, just before earnings fall.
• Debt. P/E ignores how much a company has borrowed, which is why the next lesson adds enterprise-value multiples.

Key takeaways

• P/E is share price divided by earnings per share: what investors pay per dollar of yearly profit.
• Trailing P/E uses actual past earnings; forward P/E uses analysts' estimates.
• STU Corp: trailing P/E 17.2, forward P/E 15.4, PEG about 1.4.
• PEG adjusts for growth but is crude. P/E misleads with losses, one-time items, cyclical peaks, and heavy debt.

Check your understanding

A stock trades at $60. Earnings per share were $3 last year, and analysts expect $4 next year. What are its trailing and forward P/E ratios?

1. Trailing 20, forward 15.
2. Trailing 15, forward 20.
3. Both 20.

A steel maker trades at a P/E of 5 after a record year of profits. What's the most important question?

1. Whether a P/E of 5 is the lowest in its industry, which would make it the best value.
2. Whether it pays a dividend, since a low P/E with a dividend signals a bargain.
3. Whether this year's earnings are a cyclical peak that will fall as the cycle turns.

What's next

Earnings aren't the only yardstick. The next lesson, Other Multiples: P/S, P/B, and EV/EBITDA, covers the measures investors use when earnings don't tell the full story.