How it works
Two formulas dominate. Trailing P/E uses the last 12 months of reported EPS. Forward P/E uses the next 12 months of analyst-estimated EPS. Trailing is concrete but backward-looking; forward is relevant but depends on estimates that often miss. A P/E of 20 means the price is 20 times annual earnings, implying a 5 percent earnings yield if growth is flat.
Example
Microsoft at $410 with trailing EPS of $11.50 has a P/E of 35.6. Coca-Cola at $60 with EPS $2.50 has P/E 24. ExxonMobil at $115 with EPS $9.50 has P/E 12. The lower number is not automatically cheaper: Exxon’s earnings depend on oil prices, so the market discounts them. Microsoft trades at a premium because earnings are recurring software revenue with high margins.
Why it matters
P/E is a starting filter, not a verdict. Use it relative to: the stock’s own historical range, sector peers, expected growth rate, and the broader market. The S&P 500 long-term average is near 16; a stock at P/E 30 is paying for growth, a stock at P/E 8 is being discounted for risk. Pair P/E with PEG ratio (P/E divided by growth rate) to adjust for differing growth profiles. A high P/E without growth is dangerous; a high P/E with proven 30 percent growth can be cheap.
