When I was recently studying stock valuation, I found that many beginners don’t really understand what the Price-to-Earnings Ratio means. In fact, this indicator is really important—when investing in stocks, you can hardly do without it.

Simply put, the Price-to-Earnings Ratio (P/E) tells you how many years it would take for a stock to “break even.” It also has another name: earnings multiple. In English, it’s abbreviated as PE or PER. You can calculate it by dividing the stock price by earnings per share (EPS), or by dividing the company’s market value by net profit—but usually, most people use the first method.

Taking TSMC as an example: if the stock price is 520 NT dollars and last year’s earnings per share (EPS) was 39.2 NT dollars, then the Price-to-Earnings Ratio would be 520 divided by 39.2, or about 13.3 times. In other words, you would need more than 13 years to break even on your investment, and it also implies that it would take more than 13 years for the company to earn enough to match the current market value.

A low Price-to-Earnings Ratio typically means the stock is cheap. A high Price-to-Earnings Ratio means the market is willing to assign a higher valuation, possibly because the company’s prospects look good or it is growing quickly. But here you should note that a low PE does not necessarily mean the stock price will rise, and a high PE does not necessarily mean the stock price will fall. When people are willing to give a particular stock a high valuation, it is often because they have confidence in its future development.

There are several ways to calculate the Price-to-Earnings Ratio. Static P/E uses annual EPS. This data is fixed until the new annual report is released, so the PE only changes because the stock price moves. There is also the trailing P/E, which calculates using the sum of the latest 4 quarters of EPS, helping to overcome the lag effect. In addition, there is the forward (dynamic) P/E, which uses estimated EPS—but the problem is that each institution’s estimate is different, so it’s harder to guarantee accuracy.

How do you determine whether a company’s Price-to-Earnings Ratio is reasonable? The most common approach is to compare it with other companies in the same industry, or to compare it with that company’s own historical data. PE differences across industries can be very large. For example, the automotive industry might be as high as 98, while the shipping industry might be only 1.8—so you can’t compare them at random.

If you want to directly see whether the stock price is overvalued or undervalued, you can use a P/E river chart. This chart shows several lines: by multiplying the highest and lowest historical PE values by the current EPS, you can see where the current stock price stands.

However, the Price-to-Earnings Ratio also has its limitations. It only considers the equity value and does not take a company’s debt into account. So even if two companies have the same PE, their actual risks may be different—especially for companies with different debt levels. Also, it’s difficult to define precisely whether a PE is “high” or “low.” A high PE might reflect the company facing temporary headwinds while its fundamentals remain solid, or it might be that the market is optimistic about future growth and has priced it in early. Or it could simply mean the stock has been overpurchased and needs to adjust. In addition, for new ventures or biotechnology industries that have no profits, you basically can’t calculate the Price-to-Earnings Ratio—at that point you need to use other indicators such as the price-to-book ratio or the price-to-sales ratio.

So, the Price-to-Earnings Ratio is a very practical valuation tool, but it is absolutely not the only standard for judgment. When looking at PE, you should also consider the company’s fundamentals, industry outlook, market sentiment, and more in order to make better investment decisions.