What Is Price-to-Earnings Ratio – P/E Ratio?

The price-to-earnings ratio (P/E ratio) is a valuation ratio that compares a company’s current share price to its per-share earnings (EPS). The price-to-earnings ratio, also known as the price multiple or the earnings multiple, is a ratio that compares the price of a stock to its earnings.
In an apples-to-apples comparison, investors and analysts use P/E ratios to evaluate the relative worth of a company’s shares. It may also be used to compare a company’s past performance to its own, as well as aggregate markets to one another or over time.
Pe ratio

The price-to-earnings ratio (P/E ratio) is calculated as a stock’s current share price divided by its earnings per share (EPS) for a twelve-month period (usually the last 12 months, or trailing twelve months (TTM)). Most of the P/E ratios you see for publicly-traded stocks are an expression of the stock’s current price compared against its previous twelve months’ earnings.

When p/e is very high, this means the market has noticed the efficiency of the company and has allotted its value accordingly and further price hikes may be slow. So investing in such companies will produce only normal returns in the long run, the rational being such companies personify lower risk to investors, so the principle of low returns for lower risks works here.

On the other hand picking up low p/e stocks with other parameters safe, like cashflow stability, good management, normal risks, market share etc; can lead to higher returns, when the market starts noticing such companies. This opportunity will be available for only a small time window, by the time the market starts noticing it and will drive the price to higher pe multiples.