Price-to-Earnings Ratio Analysis: An Essential Valuation Tool for Investors

The price-to-earnings ratio (P/E ratio) is one of the most critical reference indicators when investing in stocks. Investment advisors often use a company's historical P/E ratio, current stock price, and other information to assess the reasonable price of the stock. This article will provide you with a comprehensive introduction to the concept of P/E ratio, its calculation methods, application techniques, and precautions.

What is the Price-to-Earnings Ratio?

The price-to-earnings ratio, also known as PE (Price-to-Earnings Ratio), reflects how many years an investor needs to recoup their investment cost. This metric is commonly used to assess the valuation level of a company's stock.

For example, a certain technology company's current price-to-earnings ratio is about 15, which means that the company needs 15 years to earn profits equivalent to its current market value. It can also be understood that investors need 15 years to break even by purchasing that stock.

How to Calculate Price-to-Earnings Ratio?

There are two main ways to calculate the price-to-earnings ratio:

1. Stock price divided by earnings per share (EPS)
2. The company's market value divided by the net profit attributable to ordinary shareholders.

We usually use the first method for calculation.

For example, if a semiconductor company's current stock price is 320 yuan and its earnings per share in 2024 is 23.5 yuan, then its price-to-earnings ratio = 320 / 23.5 ≈ 13.6.

Classification of Price-to-Earnings Ratio

Depending on the EPS data used, the price-to-earnings ratio can be divided into historical price-to-earnings ratio and forecast price-to-earnings ratio. The historical price-to-earnings ratio can be further subdivided into static price-to-earnings ratio and rolling price-to-earnings ratio.

Static P/E Ratio (Historical P/E Ratio)

The calculation formula for static price-to-earnings ratio: PE = Stock Price / Annual EPS

The annual EPS is usually announced when the company releases its annual financial report, and it can also be derived by summing the EPS of the previous four quarters.

For example, a company's EPS for the year 2024 = Q1EPS + Q2EPS + Q3EPS + Q4EPS = 5.1 + 6.3 + 5.8 + 6.3 = 23.5.

Before the release of the new annual report, the annual EPS remains unchanged, and the change in PE is solely due to fluctuations in the stock price, thus referred to as the static price-to-earnings ratio.

Rolling Price-to-Earnings Ratio (Historical Price-to-Earnings Ratio)

The rolling price-to-earnings ratio is also known as the TTM (Trailing Twelve Months) price-to-earnings ratio, calculated over the most recent 12 months. In practice, we usually calculate it using the total EPS of the latest four quarters.

Calculation formula: PE(TTM) = Stock price / Latest four quarters EPS total

If a certain company has just announced its EPS for Q1 2025 to be 5.5, then the total EPS for the latest four quarters is: 24Q2EPS + 24Q3EPS + 24Q4EPS + 25Q1EPS = 6.3 + 5.8 + 6.3 + 5.5 = 23.9

PE(TTM) = 320 / 23.9 ≈ 13.4

It can be seen that after the new EPS was announced, the static PE remained at 13.6, while the rolling PE changed to 13.4.

predicted price-to-earnings ratio (dynamic price-to-earnings ratio)

The predicted price-to-earnings ratio is calculated using the estimated EPS.

Calculation formula: PE = Share price / Estimated annual EPS

Assuming that an institution expects the company's EPS for the fiscal year 2025 to be 25, then the dynamic PE = 320 / 25 = 12.8.

It should be noted that EPS forecasts from different institutions may vary, and companies may overestimate or underestimate EPS, thus limiting the practical utility of this indicator.

How to determine the rationality of the price-to-earnings ratio?

To determine whether a company's price-to-earnings ratio is reasonable, there are usually two methods: comparison with peers in the industry and comparison with historical data.

Comparison with the same industry

The price-to-earnings (PE) ratio levels vary significantly across different industries. For example, industry data released by a stock exchange in February 2025 shows that the average PE for the automotive industry is 75.6, while the average PE for the shipping industry is only 2.1. Clearly, it is unreasonable to directly compare companies from these two industries.

Therefore, we should choose companies in the same industry and with similar business types for comparison. Taking the semiconductor industry as an example, we can compare the price-to-earnings ratios of several major manufacturers.

As of now (2025/10/11), a leading semiconductor company's PE is 13.6, while its main competitor A company's PE is 9.5, and B company's PE is 32.4. It can be seen that the leading company's price-to-earnings ratio is at a medium level within the industry.

Historical Data Comparison

We can compare the current price-to-earnings ratio with the company's past price-to-earnings ratios to assess the company's valuation.

For example, a certain semiconductor company's current PE is 13.6, which is lower than 90% of its PE values over the past 5 years, indicating that the company's valuation is relatively cheap.

Tips for Applying Price-to-Earnings Ratio

Price-to-Earnings Ratio River Chart

The price-to-earnings ratio river chart is a tool that visually displays the valuation levels of stocks. It typically shows 5-6 lines on the stock price chart, with each line calculated based on the principle: Stock Price = EPS × Price-to-Earnings Ratio.

The line at the top represents the stock price corresponding to the historical highest price-to-earnings ratio, while the line at the bottom represents the stock price corresponding to the historical lowest price-to-earnings ratio. By observing the current stock price's position in the river chart, investors can quickly determine whether the stock is overvalued or undervalued.

The relationship between the price-to-earnings ratio and stock price ###

It is important to note that there is no necessary connection between the high or low price-to-earnings ratio and the trend of stock prices.

In other words, stocks with a low PE do not necessarily mean that their prices will rise in the future; similarly, stocks with a high PE do not guarantee that their prices will fall.

Investors are willing to give certain stocks a higher valuation, often because they are optimistic about the company's future development prospects. This explains why many tech stocks, despite having a high PE, can still see their stock prices continue to rise.

Limitations of Price-to-Earnings Ratio and Precautions for Use

Although the price-to-earnings ratio is a commonly used valuation metric, it still has some limitations. The main points include the following:

1. Ignoring the impact of debt: The price-to-earnings ratio only considers equity value and does not take into account the company's debt situation. Even if two companies have the same price-to-earnings ratio, if their levels of debt differ significantly, the actual risks they bear will also be different.

2. It is difficult to accurately define high or low: a high price-to-earnings ratio may be due to the company temporarily facing difficulties, but the fundamentals are still robust; it may also be because the market is optimistic about the company's future growth potential. Therefore, it is hard to judge whether the current price-to-earnings ratio is high or low solely based on historical experience.

3. Unable to assess unprofitable companies: For startups that have not yet achieved profitability or certain special industries (such as biotechnology), the price-to-earnings ratio will lose its meaning. In this case, we need to use other metrics to evaluate the company's value.

Comparison of PE, PB, and PS

The following is a brief comparison of three indicators: PE (Price Earnings Ratio), PB (Price to Book Ratio), and PS (Price to Sales Ratio):

After understanding the concept and calculation method of the price-to-earnings ratio, investors can apply it reasonably in their investment decisions to find stocks that align with their investment philosophy. It is worth noting that Contracts for Difference (CFD), as an emerging investment tool, provide investors with the opportunity to trade stocks in both directions, which has certain advantages over traditional investment methods, allowing investors to trade anytime and anywhere. However, CFD trading also carries high risks, and investors should carefully assess their own risk tolerance.