What is the Price-Earnings ratio (P/L)?

Key Points

• The P/E ratio shows how much investors pay for each unit of profit. A quick thermometer to feel whether stocks are expensive or cheap.

• There are several types - trailing, forward, absolute, relative. Each tells a different story. None is perfect on its own.

• It doesn't work well with cryptocurrencies. Most do not generate profits like traditional businesses. But there are interesting experiments in the DeFi world.

Introduction

Have you ever come across the term P/E ratio? It appears everywhere when we talk about investments. It's like a code that many use but not everyone understands properly. A tool that tries to reveal the real value behind stock prices.

What is the P/E ratio?

Basically, it compares price and profit. It's that simple. It shows how much you pay for each real that the company profits.

It seems trivial. It is not.

It's like figuring out if those sneakers are too expensive or a bargain. Only it's with companies.

P/E Ratio Formula

P/E Ratio = (Stock Price / Earnings per Share)

The EPS comes from the total profit divided by the available shares. Basic math, profound impact.

Types of P/E Ratios

There is no single P/E ratio. We have options:

• P/L trailing: looks back. Uses earnings from the last 12 months. The past matters.

• Forward P/E: looks ahead. Based on future estimates. Half guessing, half science.

• Absolute P/E: the raw version. Current price over recent earnings. No frills.

• Relative P/E: compares with something. It can be with competitors or with your own history.

Interpreting the P/E Ratio

High P/E? Maybe the company has a bright future. Or maybe it's too expensive.

Low P/E? It could be a hidden bargain. Or a problem approaching.

It depends. It always depends.

Technology companies usually have P/E ratios in the clouds. Public utilities are closer to the ground. Different worlds, different rules.

Why the P/E ratio is important

It's quick. It gives a general idea in the blink of an eye.

Useful for comparisons. Why does company A have a P/E of 10 and competitor B have a P/E of 30? Something doesn't add up.

Used for:

• Screening: filter opportunities. Hunt for treasures.

• Historical analysis: is the company more expensive or cheaper than in the past?

• Benchmarking: how does it compare with others?

Limitations of the P/E Ratio

It's not perfect. Far from it.

Failure when there are losses. Negative P/E doesn't make much sense.

Ignore growth. A company that grows 50% a year deserves a higher P/E ratio.

Some companies manipulate numbers. Others have extraordinary profits that will not be repeated.

And more: debts? Cash flow? P/E doesn't see any of that.

Comparing P/E ratios between sectors

Comparing P/E ratios across different sectors? A bit risky.

Tech with public services is almost like comparing a sports car to a tractor. Both have wheels, but the function is different.

A P/E ratio of 30 in technology can be normal. The same number in utilities seems alarming.

Context is everything.

P/E Ratios and Cryptocurrencies

Does Bitcoin have P/E? It doesn't make sense. It doesn't generate profits like a company.

Some DeFi platforms charge fees, generate revenue. Then they try to adapt similar metrics.

It's like making the P/E travel to another universe. It's not trivial. They're still experimenting.

Final considerations

The P/E ratio is a tool. Not a crystal ball.

Gives important clues. Quick to calculate. Easy to understand.

But never use it alone. It's like trying to understand a person just by their name. You need more context, more history.

Even so, it remains a good place to start the analysis journey.