Price to Earnings Ratio (P/E Ratio): How Investors Know If a Stock Is Overvalued or Undervalued

1. Trailing P/E Ratio

Trailing P/E uses historical earnings from the previous 12 months.

Formula:

Current Stock Price ÷ Previous 12 Months EPS

Example:

A company has:

• Stock price: $100
• Last year's EPS: $5

Trailing P/E:

100 ÷ 5 = 20

This means investors are paying 20 times the company's past earnings.

Advantages:

• Based on real financial results
• Uses actual company performance

Disadvantages:

• Does not reflect future growth expectations

2. Forward P/E Ratio

Forward P/E uses estimated future earnings.

Instead of looking at what the company earned in the past, it looks at what analysts expect the company will earn.

Example:

Stock price:

$100

Expected EPS next year:

$10

Forward P/E:

100 ÷ 10 = 10