P/E ratio: a universal tool for valuation or an outdated method?

The essence of the indicator: what investors need to know

The P/E ratio ( price-to-earnings ratio ) remains one of the most discussed metrics in investment practice. It shows what price the market is willing to pay for a unit of the company's income. In simple terms: if the company earned $1, and the investor pays $20, the ratio is 20.

The calculation is extremely simple:

P/E = Market Capitalization / Net Income or Share Price / Earnings Per Share (EPS)

To obtain EPS, the company's total income for the period is taken, taxes and dividends on preferred shares are subtracted, and then divided by the number of common shares outstanding.

Three Types of P/E and Their Practical Application

Analysts distinguish several types of this indicator depending on the data source:

Current P/E uses actual financial results from the last 12 months. This is the most reliable option, as it is based on actual data rather than forecasts.

Forward P/E is based on expected earnings over the next 12 months. Here, subjectivity comes into play: analysts' estimates can vary significantly.

Historical comparison compares the company's current indicator with its own values in the past. This helps to understand whether the market's opinion about the firm has changed.

Industry comparison places the company's P/E alongside the average sector metric. This is particularly important as different industries have fundamentally different norms.

Why a high P/E is not always bad, and a low one is not always good

The interpretation of the coefficient requires context. A high value often means that investors expect significant profit growth and are willing to pay a premium. A low value may signal undervaluation or problems in the business.

Real-world example: technology companies typically have a P/E of 25-40, while utilities have a P/E of 10-15. This does not mean that the tech sector is overvalued. There is a different logic at play here: IT companies grow faster, so investors accept a higher ratio.

Comparing Apple ( technology) with EDF ( electricity) by P/E is a mistake. One should look at companies within the same category.

Advantages: why this indicator remains popular

Quick assessment: in a minute you can get an idea of whether a stock is overvalued or undervalued.

Portfolio Filtering: Investors use P/E to sift through potentially interesting securities before a more in-depth analysis.

Dynamic analysis: comparing the company's P/E ratio over different years shows how the market's perception of its prospects has changed.

Industry benchmark: when a company's P/E significantly differs from the sector average, it's a reason to investigate why.

Serious limitations of the method

The P/E ratio has significant drawbacks that cannot be ignored:

It does not work at a loss. If the company is losing money (negative profit), it is impossible to calculate the indicator.

A high P/E may be justified for a young growth company, but it is absurd for a stable enterprise. The metric does not differentiate between these situations.

Companies sometimes manipulate their reporting — shifting expenses to the next quarter or using accounting schemes to inflate profits.

P/E ignores debt load, cash flow, asset quality, and dozens of other critically important factors.

Therefore, professionals never make investment decisions based solely on P/E. They look at revenue, operating margin, debt, free cash flow, and a multitude of other metrics.

Where P/E Doesn't Work at All: Cryptocurrencies and DeFi

Here is the main paradox: the P/E ratio cannot be applied to most cryptocurrencies.

Bitcoin, Ethereum, and thousands of altcoins do not publish profits. They are not companies — they are protocols or assets without financial reporting. How to calculate P/E if there is no E (earnings)?

However, the situation is more interesting in the ecosystem of decentralized finance (DeFi). Some protocols (for example, lending platforms) earn from fees and can reinvest these revenues. Analysts are experimenting with evaluation methodologies for such platforms, using logic similar to P/E: they compare the market capitalization of the protocol with its annual revenue from fees.

But this is still a niche approach that has not been standardized. The cryptocurrency market still evaluates assets through the lens of supply/demand rather than financial performance.

Practical Output

The P/E ratio is a useful but incomplete tool. It is ideal as a first filter when selecting stocks, but cannot be the only criterion.

Investors should consider the P/E in context:

• Company revenue growth
• Profitability rates
• Debt Level
• Market positions
• Macroeconomic situation

Only a comprehensive approach provides a real understanding of the asset's value.