P/L: understand this indicator that makes investors buy or sell

What does P/E mean and why should you know?

The Price-Earnings ratio (P/E) is basically a conversation between the price you pay for a stock and how much the company actually earns. Simple as that. The lower the number, the apparently cheaper you are paying. The higher it is, the more investors believe that this company will grow a lot.

The formula is straightforward: divide the stock price by the company’s earnings per share (EPS). Done. This number tells you how many dollars investors are willing to spend for each dollar of profit the company generates.

Not all high P/E is bad (and not all low P/E is a bargain)

This is where most make mistakes. A high P/E can mean two completely different things:

• The stock is too expensive (bubble)
• Investors believe the company will grow exponentially

And a low P/E can indicate:

• Buying opportunity
• Or simply a company in trouble

Context is everything. Technology companies naturally have higher P/E ratios because they are in rapid growth. Public utility companies tend to have low P/E because they always earn predictably, without big surprises.

Three different ways to look at P/E

Historical P/E (trailing) is based on what the company has already earned in the last 12 months. It’s the most reliable because it uses real, already accounted-for numbers.

Forward P/E (forward) uses forecasts. Analysts estimate how much the company will earn in the next 12 months. More optimistic, but also riskier.

Absolute P/E is just the raw formula — no comparison to anything. You see the number and that’s it.

Relative P/E compares the company with competitors or the industry average. This helps understand if the price makes sense within the industry context.

How this indicator helps when choosing stocks

P/E is a quick tool to filter options. If you’re looking at two companies in the same sector and one has a much higher P/E, it’s worth investigating why — maybe it has a more aggressive growth plan or maybe it’s just a bubble.

It also works well to:

• Track potentially undervalued stocks
• Monitor how the market’s opinion about a company is changing (by comparing the current P/E with the historical)
• Benchmark against competitors or the market average

The pitfalls nobody warns about

P/E doesn’t work if the company is losing money — the formula simply breaks. It also completely ignores profit quality: a company could be manipulating its numbers to look better. And there are important details that P/E doesn’t capture, such as huge debts, weak cash flow, or other issues.

Another point: P/E doesn’t explain different growth rates. A rapidly exploding startup can legitimately have a high P/E, while a mature multinational having a low P/E is normal. Use P/E as a starting point, not the final answer.

And Bitcoin? And cryptocurrencies?

This is where it gets tricky. P/E was designed for companies with clear profits and audited reports. Bitcoin and most cryptocurrencies don’t work that way — they don’t generate profits like a traditional company would.

Now, in some parts of DeFi, analysts are experimenting with similar concepts. For example, if a platform earns from trading fees, you could try to evaluate the token considering those fees as “profit.” But these methods are still very experimental and not industry consensus.

In practice: how to use this now

Before buying a stock, look at its P/E. Compare it with others in the same sector. If it’s unusually high or low, investigate why — read press releases, follow company news. Use P/E along with other indicators: revenue, margins, debt, historical growth.

The P/E ratio is a powerful tool when you understand its limitations. It’s not a crystal ball, but it helps a lot to separate the wheat from the chaff when investing.