The price-to-earnings ratio

The price-to-earnings ratio is the share price divided by earnings per share. At 20x, you are paying twenty dollars for each dollar the company earned in a year. Turn it upside down and you get the earnings yield: 20x is 5%, which is the more useful form when you want to compare a company against a bond.

That is the whole of it arithmetically. Everything difficult about the P/E is in the denominator.

A trailing P/E uses the last twelve months of reported earnings. It is a fact: the earnings happened and were audited. A forward P/E uses an analyst estimate of the next twelve months, so it is a forecast wearing the same notation, and it is almost always the lower of the two because estimates usually assume growth.

Comparing one company on a trailing basis with another on a forward basis produces a difference that is entirely an artefact of which number you picked. The figures shown on company pages here are trailing twelve month unless labelled otherwise.

A company with no profit has no meaningful P/E. The arithmetic yields a negative number, which is not a cheap valuation, it is an absence of one. Most screeners hide negatives for that reason rather than ranking them.

Earnings are also an accounting figure rather than cash, and they contain one-off items: a legal settlement, an asset sale, a writedown. A single unusual quarter can halve or double a trailing P/E without anything about the business changing. This is the most common way the ratio lies to a casual reader.

And it is not comparable across industries. Banks, insurers, utilities, software companies and miners carry structurally different multiples because their earnings have structurally different durability. A 12x utility is not cheaper than a 30x software company; the two numbers are not answering the same question.

A high multiple means the market expects earnings to grow. A low one means it does not, or that it doubts the earnings will persist. Neither is a verdict, and both are frequently right - low multiples cluster in industries in genuine decline, and the cheapest ratios on any screen are usually cheap for reasons the ratio cannot show you.

The ratio is a question rather than an answer: it tells you what the market is assuming, which is the starting point for deciding whether you agree.