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P/E Ratio Explained: How to Tell If a Stock Is Cheap or Expensive
Ruby Layram
1st Sep 2026
If you’ve ever read a stock tip that says a share “looks expensive on a P/E of 30” and had no idea what that meant, you’re not alone. The price-to-earnings ratio, or P/E ratio, is one of the most commonly used numbers in investing, and it’s also one of the easiest to understand once someone explains it without the jargon. This guide walks through what it is, how to work it out, what counts as “good,” and where it can mislead you.
What is the P/E ratio?
The P/E ratio compares a company’s share price to how much profit it makes per share. It answers a simple question: how much are you paying, as an investor, for every £1 of a company’s profit?
The formula is:
P/E ratio = Share price ÷ Earnings per share (EPS)
Earnings per share, or EPS, is simply the company’s total profit divided by the number of shares it has issued. Most investment platforms and finance websites display both the EPS and the P/E ratio for you, so you rarely need to calculate it by hand, but understanding the formula makes the number far easier to interpret.
A worked example
Say a company’s shares are trading at 800p, and over the last year it made a profit equivalent to 40p per share. Its P/E ratio would be:
800p ÷ 40p = 20
A P/E of 20 means investors are currently willing to pay 20 times the company’s annual profit to own a share of it. Put another way, if the company kept making exactly the same profit every year and paid it all out, it would take 20 years of earnings to “earn back” the current share price. That’s obviously a simplification, profits rise and fall, and companies don’t pay out 100% of earnings, but it’s a useful mental shortcut for what the ratio represents.
What counts as a “good” P/E ratio?
This is the part most guides gloss over: there is no single number that makes a P/E ratio good or bad on its own. It only means something in context. A few reference points:
- Historically, the UK’s FTSE 100 has traded on an average trailing P/E of roughly 14 to 17, though this shifts with interest rates and market sentiment, so always check the current figure rather than relying on an old average.
- A lower P/E (roughly under 12-15) can mean a stock is undervalued and overlooked, or it can mean the market expects its profits to fall, both are common, and the ratio alone won’t tell you which.
- A higher P/E (25+) often means investors expect strong future growth, common in technology and early-stage healthcare companies, but it also means you’re paying a premium, and any disappointment can hit the share price hard.
- Comparing a company’s P/E to others in the same sector is far more useful than comparing it to the market as a whole. A bank, a utility and a software company have very different “normal” P/E ranges, so compare like with like.
Trailing P/E vs forward P/E
You’ll sometimes see two versions of the ratio. Trailing P/E uses the company’s actual profit over the last 12 months, it’s based on real, reported numbers. Forward P/E uses analysts’ predicted profit for the year ahead, it’s more useful for judging future value, but it relies on estimates that can turn out to be wrong. Neither is “more correct”, they just answer slightly different questions, so it’s worth checking which one you’re looking at on any platform or app.
Where the P/E ratio can mislead you
A single number can never tell the whole story. Some situations where P/E needs extra care:
- Loss-making companies. If a company has no profit, or a loss, it has no meaningful P/E ratio at all (you’ll often see “N/A” or a negative number), which doesn’t necessarily mean it’s a bad investment, some early-stage or fast-growing companies are deliberately unprofitable while they expand.
- Cyclical businesses. Companies like housebuilders, miners or airlines see profits swing sharply with the economic cycle, so a low P/E at the top of a boom can be a warning sign, not a bargain.
- One-off items. A big asset sale or a legal settlement can temporarily inflate or shrink reported profit, distorting the ratio for a year or two.
- It ignores debt. Two companies with an identical P/E ratio can carry very different levels of debt, which changes how risky they really are. Metrics like the PEG ratio (P/E relative to growth) or EV/EBITDA are often used alongside P/E for a fuller picture.
What to Do Next
- Look up the P/E ratio for a stock you’re curious about on your investment platform or a free tool like the London Stock Exchange website, Google Finance, or your broker’s research pages.
- Compare it with two or three other companies in the same sector, not the market average, to see whether it looks high, low, or roughly in line.
- Check whether you’re looking at trailing or forward P/E, and note which one, so you’re comparing like with like next time.
- Treat P/E as a starting point, not a verdict. Use it alongside the company’s debt levels, profit trend, and dividend history before drawing any conclusions.
- If a P/E ratio looks unusually low or high, ask why, rather than assuming it’s automatically a bargain or automatically overpriced.
This article is for general information and education only. It is not regulated financial advice, and MoneyMagpie is not a financial adviser. The P/E ratio is one tool among many and should not be used in isolation to make investment decisions. The value of investments can go down as well as up, and you may get back less than you invest. Please do your own research or speak to a regulated financial adviser before investing.
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