Understanding P/E Ratio

The Most Common Valuation Metric

The Price-to-Earnings (P/E) ratio tells you how much investors are paying for each dollar of company earnings. It's calculated by dividing the stock price by earnings per share.

P/E Ratio = Stock Price ÷ Earnings Per Share

If a stock trades at $100 and earns $5 per share, the P/E is 20. This means investors are paying $20 for every $1 of annual earnings.

Graham's Maximum P/E of 15

Benjamin Graham recommended never paying more than 15 times earnings for a stock. At P/E 15, you're paying 15 years worth of current earnings for the company. That's already quite optimistic.

Higher P/E ratios mean investors expect significant earnings growth. But growth is uncertain—Graham preferred to pay for what the company earns today, not what it might earn tomorrow.

The investor should never buy a stock because it has gone up or sell one because it has gone down.

— Benjamin Graham

What High P/E Means

A high P/E ratio (above 20-25) usually means: investors expect strong future growth, the stock might be overvalued, or you're paying a premium for quality.

Example: Tesla (TSLA) often trades at P/E ratios above 50. Investors expect massive growth, but if growth disappoints, the stock can crash.

What Low P/E Means

A low P/E ratio (below 10-12) usually means: the market expects declining earnings, there's a problem investors see that you might not, or it's genuinely undervalued.

Low P/E alone doesn't make a stock a buy. You need to understand WHY it's cheap. Sometimes low P/E is a trap—the 'value trap'—where earnings are about to fall.