What is the price-to-earnings ratio calculated by comparing?

The price-to-earnings ratio, or P/E ratio, is calculated by comparing a company’s share price with its earnings per share. The basic formula is share price divided by earnings per share.

If a stock trades at $40 and the company reports $2 of earnings per share, its P/E ratio is 20. Investors often interpret that figure as the price paid for each unit of the company’s current or expected earnings, although it is not a literal guarantee of future returns.

Analysts distinguish trailing P/E, based on past earnings, from forward P/E, based on estimated future earnings. A P/E ratio can be low because a company is undervalued, cyclical, distressed, or expected to deteriorate; a high ratio can reflect expected growth, quality, or excessive optimism. P/E is less useful when earnings are negative, and comparisons are most meaningful among companies with similar industries, accounting contexts, and growth patterns.