What is a stock\u0027s P/E ratio and how to read it
The P/E (Price to Earnings) measures how many euros you pay for each euro of a company's annual profit. It's the most famous ratio for valuing stocks, and also the most misunderstood. Well understood, it's a compass; misused, a trap.
What it measures exactly
If a stock costs €100 and the company earns €5 per share a year, its P/E is 20 (100 ÷ 5). It reads as "investors pay 20 times annual profit". Another way to see it: at that profit rate, you'd take 20 years to recover what you paid. The higher the P/E, the more expensive each euro of profit you're paying.
High vs low P/E
A high P/E (e.g. 40) means the market expects a lot of future growth: it pays dearly today expecting bigger profits tomorrow. A low P/E (e.g. 8) can mean the stock is cheap... or that the market distrusts its future. The number alone doesn't say if it's a good or bad buy.
Context is everything
A P/E only makes sense compared: with its own sector, its historical average, and its growth. A P/E of 30 can be cheap in a tech firm doubling profits yearly, and very expensive in a barely-growing bank. Comparing the P/E of companies from different sectors is a classic mistake.
The low-P/E trap
Seeing a P/E of 5 and thinking "so cheap!" is dangerous. Sometimes it's low because the market anticipates profits will fall (a declining company). The P/E uses past profit; if the future is worse, that "cheap" P/E is a mirage. Cheap and declining isn't an opportunity, it's a value trap.
What it means for you
The P/E is a starting point, not a conclusion. Use it to ask questions ("why does this trade at 40 and its competitor at 15?"), not to decide on its own. And always compare it within the same sector and against the company's growth.
Where to start
Take a company you know, look at its P/E (it's on any financial website) and compare it with two competitors in the same sector. That comparison will teach you more about valuation than memorising which number is "high" or "low".