Stock value from the perspective of earning potential: understanding the P/E ratio

Why the price/earnings ratio is needed

When you choose a stock, you need to understand: is it worth overpaying for this asset? The P/E ratio gives a quick answer. It shows how much investors are willing to pay for every dollar of the company's earnings. Simply put, if a company has a low P/E, it is either undervalued or it has issues. A high P/E usually means that the market expects strong growth in the future.

How to calculate this coefficient

The formula is simple: P/E = stock price / earnings per share (EPS)

The EPS indicator is how much net income the company earned per share. To calculate it, you need to take the company's net profit ( after taxes and dividends) and divide it by the number of common shares outstanding.

Sounds complicated? In practice, it's simple: take the stock price (, it's visible everywhere ), take the EPS figure (, companies publish this ), divide one by the other — done.

What types are there

The P/E ratio can be viewed from different angles:

Current P/E — based on actual earnings over the past 12 months. This is the most reliable figure because the money has already been earned.

Projected P/E - calculated based on how much analysts believe the company will earn in the next 12 months. A more optimistic scenario depends on the forecasts.

Absolute P/E - you simply take the current price and divide it by the last EPS figure. No comparisons, just facts.

Relative P/E - you compare the company's ratio to what it is for the entire industry or what it was for the same company in the past. This helps to understand whether the price is inflated specifically for this sector.

How to correctly read the result

A high P/E is not always a bad thing. If a company is growing quickly, investors are willing to pay more for a dollar of profit. Technology companies often have P/Es above 20-30 because their dynamic growth is expected. In contrast, utility companies usually trade with a P/E below 15 — a stable business, but without explosive growth.

A low P/E can mean two things: either the stock is genuinely undervalued, or the company has fundamental issues. Therefore, comparisons should be made within the same industry.

What does this coefficient provide to investors

Quick Screening - filter potentially undervalued stocks with just a few clicks.

Historical context - you compare the current P/E of the company with its own indicators from previous years. If it has dropped, could it be that the market has lost interest in it? Or is the pessimism temporary?

Inter-company comparison - you place the P/E ratios of two competitors side by side. If both have a high P/E but one is growing faster, the first may be overvalued.

What's the catch

The P/E ratio is not a panacea. It has serious limitations:

Does not work with unprofitable companies. If the firm is losing money, the EPS indicator is negative, and calculating P/E is meaningless.

Does not fully account for growth dynamics. A high P/E may be justified for a young, fast-growing startup, and completely unwarranted for a mature company. Context is everything.

Companies can manipulate their reporting. If lawyers advise on how to reclassify expenses, the EPS figure can be inflated.

Ignores other factors. Debt load, cash flow, asset quality — all of this is not shown by P/E. You also need to look at revenue, net profit, and debt levels.

Industry Differences

Comparing the P/E of companies from different sectors is meaningless. A tech startup with a P/E of 50 can be cheaper than a bank with a P/E of 10 if the growth rates meet expectations.

Technology Sector: high ratios (20-40+) — the market believes in the speed of growth.

Financial Sector: average ratios (8-15) — stable income, modest growth.

Utilities: low rates (10-15) — monopolized markets, predictable profits.

Does P/E Work for Cryptocurrencies

Honest answer: no, it does not work for most tokens.

Bitcoin and the overwhelming majority of cryptocurrencies do not publish financial reports. They do not have “profits” in the classical sense — they are just digital assets. Therefore, the EPS indicator cannot be calculated for them, and the entire P/E ratio becomes meaningless.

But there is an interesting exception. In decentralized finance (DeFi), some protocols do generate commission income. Analysts there are trying to apply similar methods — they look at how many times the market capitalization of the protocol exceeds its annual income. These are still experimental approaches, not standardized, but they show that financial metrics are indeed penetrating into crypto.

Conclusion

The P/E ratio is an old, time-tested metric that helps quickly assess whether a stock is expensive. It does not provide the complete picture, but it is an excellent starting point. The EPS figure, from which the P/E is calculated, shows the actual ability of a company to make money. Use this ratio alongside other metrics: look at debts, cash flows, and revenue growth rates. Only such a comprehensive approach will give you a real understanding of the asset's value.