The P/E Ratio — What's a Good Number?

The P/E ratio is the first number most investors learn, and it's dangerously easy to misuse. It tells you how much investors are willing to pay for each dollar of a company's earnings. A P/E of 20 means investors pay $20 for every $1 of annual earnings. But knowing the number is easy — knowing what it means requires understanding context, growth rates, and quality. A P/E of 10 isn't always cheap, and a P/E of 40 isn't always expensive.

How It Works

P/E Ratio = Stock Price / Earnings Per Share (EPS)

There are two versions:

Trailing P/E uses the past 12 months of actual earnings. It's based on real numbers, but it's backward-looking — it tells you what the company earned, not what it will earn.

Forward P/E uses analysts' estimated earnings for the next 12 months. It's more forward-looking but based on projections that may be wrong.

The S&P 500's average P/E ratio since 1926 is roughly 16-17x. This means investors have historically been willing to pay about $16-$17 for every $1 of annual earnings from large U.S. companies. When the S&P 500 trades above 20x, it's historically expensive. Below 12x, historically cheap.

But averages hide important nuances. In the 1990s, the average P/E expanded from 15x to 30x as the internet revolution created genuine growth. In 2008, the P/E collapsed to 10x during the financial crisis. In 2024, the S&P 500 traded around 21x forward earnings — elevated by historical standards, but not extreme given low interest rates and strong corporate profitability.

The PEG ratio (P/E divided by earnings growth rate) provides additional context. A stock with a P/E of 30 and 30% earnings growth has a PEG of 1.0 — fairly valued relative to its growth. A stock with a P/E of 15 and 5% growth has a PEG of 3.0 — expensive for its growth rate. Peter Lynch considered a PEG under 1.0 attractive and above 2.0 expensive.

The Shiller P/E (CAPE ratio) uses 10 years of inflation-adjusted earnings instead of one year, smoothing out cyclical fluctuations. The long-term average is about 17. As of 2024, it stood around 33 — well above average, suggesting the market was priced for strong future earnings growth.

Why It Matters for Investors

The P/E ratio is a shorthand for how much optimism is baked into a stock price. A high P/E means investors expect strong future growth. A low P/E means investors expect weakness, stagnation, or problems. Neither is inherently good or bad — the question is whether the expectations are justified.

Here's a framework for interpreting P/E ratios:

• P/E under 10: Very cheap. Either a deep value opportunity or a company in serious trouble. Requires investigation — why is it this cheap?
• P/E 10-15: Below average. Often found in mature, slow-growth industries (banks, utilities, energy). Can signal good value if the company is stable.
• P/E 15-20: Average to fair value for the broader market. Neither cheap nor expensive.
• P/E 20-30: Above average. Justified for companies growing earnings 15%+ per year. Dangerous for companies growing 5% per year.
• P/E above 30: Expensive by historical standards. Only justified for companies with exceptional, sustainable growth. Many great growth stocks trade here — but many busts start here too.

Never compare P/E ratios across industries. A utility company at 18x P/E is expensive. A technology company at 18x P/E is cheap. Each industry has its own norms based on growth rates, capital intensity, and competitive dynamics.

Real Example

Let's look at how P/E ratios told the story in real scenarios:

Amazon at a P/E of 3,000 (2012): Amazon traded at absurd-looking P/E ratios for years because it reinvested all its earnings into growth. Its P/E appeared insanely expensive, but its revenue was growing 20-30% per year and it was building what would become the world's largest cloud computing business (AWS). Investors who focused on traditional P/E missed one of the greatest stocks of the decade. Amazon went from $250 to $3,700 between 2012 and 2021. The P/E was "lying" because earnings were artificially suppressed by deliberate reinvestment.

Citigroup at a P/E of 8 (2007): Citigroup traded at just 8x earnings heading into the financial crisis. Value investors piled in, thinking it was cheap. But those "earnings" included massive profits from subprime mortgage securities that were about to become worthless. When the crisis hit, Citigroup's stock dropped 95% from peak to trough. The P/E was low for a reason — the earnings weren't real.

Apple at a P/E of 10 (2016): Apple traded at about 10x earnings, far below the market average of 18x. The market worried that iPhone growth was slowing. But Apple's services revenue was just starting to accelerate, its ecosystem of 1 billion+ users was incredibly sticky, and it was generating $50+ billion in annual free cash flow. Buffett recognized the disconnect and bought aggressively. The stock tripled in the next four years.

The lesson: P/E is a starting point for analysis, not a conclusion. It tells you how much you're paying — but you need to understand what you're paying for.