The price-to-earnings (P/E) ratio compares a company's share price to its earnings per share, indicating how much investors are willing to pay for each pound of earnings. A higher P/E suggests investors expect higher future growth. It is the most widely used equity valuation multiple and a key input for comparable company analysis.
Formula
P/E Ratio = Share Price / Earnings Per ShareIn Depth
The P/E ratio is the starting point for most equity valuation discussions. By dividing the current share price by EPS, it tells investors how many years of current earnings they are paying for — or equivalently, what return they expect.
Trailing P/E uses the last twelve months of actual earnings. Forward P/E uses analyst consensus EPS forecasts for the next twelve months. Forward P/E is generally more useful because investors buy future earnings, not past performance.
P/E ratios vary enormously by industry, growth rate, and risk profile. High-growth UK technology companies may trade at P/E ratios of 30-50x, reflecting expectations of rapid earnings growth. Mature utilities might trade at 10-15x. The FTSE 100 average has historically ranged from 12-18x.
FP&A teams use P/E ratios in several contexts. For comparable company analysis, the P/E ratios of listed peers provide a benchmark for valuing the company. For M&A, the target's P/E relative to the acquirer's determines whether a deal is earnings-accretive or dilutive. For incentive planning, implied P/E multiples help translate EPS targets into share price expectations.
Limitations include its inapplicability to loss-making companies, sensitivity to one-off items in earnings, and the difficulty of comparing P/Es across sectors with different growth profiles. The PEG ratio (P/E divided by earnings growth rate) addresses the growth comparison issue.
Real-World Example
A UK mid-cap company trades at 320p with trailing EPS of 20p (trailing P/E of 16x) and consensus forecast EPS of 24p (forward P/E of 13.3x). Listed peers trade at forward P/Es of 15-18x. The FP&A team notes that applying the peer median of 16.5x to the forecast EPS would imply a share price of 396p — 24% upside — supporting the CFO's view that the market undervalues the company.
Related Terms
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Comparable company analysis (comps) values a company by comparing its financial metrics against simi...
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