What is P/E: A tool for measuring stock value that investors need to know

When the stock market declines, you may see your favorite stocks dropping in price. But the big question is: Are these prices truly justified? Is this a good buying opportunity or just a trap? And importantly, how many years will it take to realize the profits?

In the world of investing, whether a stock is cheap or expensive depends on each individual’s perspective. But if we look from an academic standpoint and seek standard metrics, there are several methods to choose from. The P/E ratio (Price-to-Earnings ratio) is a model that stock analysts and value investors (Value Investor) consider a primary tool for assessing whether a stock price is reasonable.

What does the P/E Ratio mean?

P/E stands for Price per Earning ratio — the ratio between the stock price and earnings per share. It tells you: If you buy the stock at the current price, how many years will it take to recover your initial investment from the company’s profits? Assuming the company makes consistent profits each year.

How to calculate the P/E ratio

The calculation is very simple:

P/E = Stock Price ÷ EPS (Earnings Per Share)

Both variables are key:

Current Stock Price (Price) is the amount you pay to own the stock. The lower the purchase price, the lower the P/E, and the shorter the payback period.

Earnings Per Share (EPS - Earning Per Share) is the company’s net profit divided by the total number of shares outstanding. A high EPS indicates the company is good at generating profits. Even if you pay a high price, the P/E might not be high because the denominator is large, making the payback period shorter.

Remember: Low P/E = Cheap stock + Fast payback = Quick profit realization

For example: You buy a stock at 5 baht per share, with an EPS of 0.5 baht. The P/E ratio is 10 (5 ÷ 0.5 = 10). This means the company will return 0.5 baht annually. After 10 years, you will have recovered your initial investment of 5 baht — the cost recovery point. From the 11th year onward, all profits are net gains.

Forward P/E vs Trailing P/E: Which is better?

There are two common types of P/E used by investors, but they differ:

Forward P/E (P/E Forward)

This method uses the current stock price divided by projected future earnings (generally the expected EPS for the next year).

Advantages: It helps you see the company’s growth potential. If profits are expected to increase, forward P/E provides a more realistic picture.

Disadvantages: It relies on estimates and analyst opinions. Companies may underestimate profits to meet target P/E when actual results are announced, which can distort the data.

Trailing P/E (P/E Historical)

Uses the current stock price divided by actual EPS over the past 12 months.

Advantages: Uses real data, no guessing involved. Easy and quick to calculate. Some investors prefer this because they don’t have to rely on estimates.

Disadvantages: Past performance does not guarantee future results. If the company faces major changes, trailing P/E may reflect the situation with a delay.

When P/E changes: potential disasters ahead

The P/E value is not fixed; it changes with the company’s circumstances.

Imagine: You buy a stock at 5 baht with an EPS of 0.5 baht (P/E = 10), expecting to recover your investment in 10 years.

Then what changes? The company expands its product lines, enters new markets, and experiences good profit growth → EPS jumps to 1 baht per share. At this point, P/E drops to 5 (5 ÷ 1 = 5). This means the payback period is now only 5 years! This is a rain after a drought.

Conversely: Suppose the company faces obstacles, such as trade restrictions or damages, causing EPS to fall to 0.25 baht per share. Then, P/E skyrockets!! Remaining at 5 ÷ 0.25 = 20 times. Now, you need to wait 20 years!!

This illustrates why P/E can be misleading. Its value depends on the company’s profits, which are influenced by many variables not accounted for in the formula.

Limitations to be aware of

P/E has the power to indicate whether a stock is cheap or expensive, but it is not a directional arrow.

Past performance does not guarantee future results — EPS in previous years does not indicate the same will happen next year.

P/E does not consider other factors — a company may have a low P/E but high debt or management issues.

Forecasts are often uncertain — Forward P/E relies on predictions that humans are not always good at making.

Therefore, while P/E is an excellent screening tool for stocks and comparing different stocks, it should be used as a starting point, not the final decision.

Practical tips: How to use P/E effectively

1. Use P/E as an initial filter — select stocks with low P/E compared to last year or relative to industry peers.
2. Apply critical judgment — ask yourself: Why is the P/E low? Can the EPS be maintained or grow?
3. Combine with other indicators — look at debt-to-equity ratio, ROE, growth rates, etc.
4. Monitor changes — when EPS increases, how does P/E behave? This tells the story of your investment.

Maximize the benefits of the P/E ratio

What is the P/E ratio? It’s a bridge connecting the price you pay with the profit you expect to receive, indicating how many years it will take to recover your investment.

Using the P/E ratio as an evaluation tool is not perfect, but it’s a good starting point for investors seeking precision in stock selection. Be aware of its limitations, supplement it with other data, and with experience, you will gain a clearer picture of your investment landscape.