The stock market has fallen like this, many people are probably looking for cheap stocks, but the problem is they don't know if the current price is truly cheap or not. Should they buy now? Will they make a profit if they do? And how many years will it take to break even?

Are there answers to questions like this? Yes, there are. But you need the right tools. Most investors who think about the intrinsic value of stocks almost always mention the PE ratio because it’s a key indicator that helps measure whether a stock is undervalued or overvalued.

So, what exactly is the PE ratio? Simply put, the PE ratio or Price-to-Earnings ratio is the stock price divided by earnings per share. It tells you how many years it would take to recover your investment if the company’s profit remains the same every year.

The calculation is straightforward: PE = stock price divided by EPS (earnings per share). The first part is the price you pay; the lower the purchase price, the lower the PE, and the faster the break-even point. The second part is EPS, which is the net profit the company makes on average per share in that year. If a company has a high EPS, even if the stock price is high, the PE could still be low because the denominator is large.

For example, buying a stock at 5 baht with an EPS of 0.5 baht results in a PE of 10. This means the company pays out 0.5 baht annually, and it would take 10 years to recover your investment. From year 11 onward, it’s pure profit. The lower the PE, the faster the break-even point and the quicker you start making a profit.

However, the PE ratio has two types: Forward PE and Trailing PE. Forward PE uses the current price divided by projected future earnings. It’s like asking, “If the company grows as expected, is the current price fair?” But the problem is some companies might underestimate their earnings to appear undervalued or analysts might misjudge.

Trailing PE uses actual data from the past year, dividing the current price by the EPS from the previous 12 months. This method is more popular because it relies on real data and is quick to calculate. Many investors prefer this because they don’t have to rely on forecasts, but the downside is that past performance doesn’t guarantee future results.

Discussing the limitations of the PE ratio, this is where investors need to be cautious. EPS isn’t constant; it changes all the time. For example, if you buy a stock at 5 baht with an EPS of 0.5 baht and a PE of 10, expecting to wait 10 years, but during that time, the company expands its market and production, causing EPS to rise to 1 baht. The PE then drops to 5, and the break-even point shortens to 5 years. Conversely, if negative events occur, such as restrictions or legal damages, EPS might fall to 0.25 baht, and the PE could rise to 20, meaning a 20-year wait to recover your investment.

Therefore, the PE ratio is a useful tool but not the sole decision-maker. It helps compare whether stocks are undervalued or overvalued using a common standard. After selecting stocks based on PE, you should also study other factors—look at profit trends, company health, and the market the company operates in. Doing so can significantly reduce investment mistakes.

Investing in stocks doesn’t rely on just one tool. The market is volatile; sometimes technical analysis, sometimes fundamentals. When the market drops like this, those who understand the PE ratio and know how to use it can accurately time their entry to buy good stocks, add undervalued stocks to their portfolio, and wait for the company to grow.