## What is the Use of P/E Ratio? Valuation Secrets Every Investor Should Know

### Key Points

- The P/E ratio reflects the price investors are willing to pay for each dollar of earnings from a company, serving as a quick tool to assess whether an asset is overvalued or undervalued.
- Different types of P/E ratios (trailing, forward, absolute, relative) each have their own focus and need to be understood in conjunction with industry background and growth potential.
- Most crypto assets are not suitable for P/E ratios, but DeFi platforms generate fee income, and some metrics are in the exploratory stage.

### Is the P/E ratio really useful? Investors' "quick filter"

When investing in stocks, you may hear the term "P/E ratio." Simply put, it is the **price-to-earnings ratio** — comparing a company's stock price with its earning ability, helping you determine whether the stock is worth buying.

How is it calculated specifically? It is calculated by dividing the stock price by the earnings per share (EPS). The earnings per share is obtained by dividing the total profit of the company (after tax and after preferred stock dividends) by the number of outstanding shares. In other words, the P/E ratio tells you how much investors are willing to pay for every dollar the company earns.

### Four Ways to Play the P/E Ratio

In practice, the P/E ratio has multiple versions, each with a slightly different perspective:

**Trailing P/E**: Based on the actual profits of the past 12 months, it reflects the true performance of the company and is the most commonly referenced data.

**Forward P/E**: Based on analysts' forecasts of earnings for the next 12 months, it reflects market expectations and optimism more.

**Absolute P/E**: The most straightforward calculation - current price divided by the latest earnings per share, without comparison to any benchmark.

**Relative P/E**: Compare a company's P/E with the industry average or historical performance to see if it is overvalued or undervalued.

How to interpret the P/E number?

The key to understanding the P/E ratio is to **look at the context**. A high P/E may indicate that investors expect significant growth in the company's future profits and are willing to pay for it. Conversely, a low P/E may suggest that the stock is undervalued or that the company is facing difficulties.

But there is an important reminder here: what is considered "high" and what is considered "low" depends on the industry. For example, technology companies often have much higher P/E ratios than energy companies due to their greater growth potential. This is not an unreasonable price, but rather a pricing difference in the market based on the risks and returns of different industries.

### Why do investors value the P/E ratio so much?

The P/E ratio is a powerful tool for quick valuation, especially suitable for comparing companies within the same industry. For example, if one tech company has a P/E significantly higher than another, you should dig deeper: is this premium supported by strong growth expectations? Or are there other factors at play?

Investors often use P/E to do the following things:

**Screening Opportunities**: Use P/E as a filter to quickly find potentially undervalued stocks.

**Backtrack History**: Compare the company's current P/E with historical levels to see how market sentiment has changed.

**Industry Benchmarking**: Compare the company's P/E with the industry average to assess relative attractiveness.

### There are many "pits" in the P/E ratio.

Although P/E is very useful, it is far from perfect:

**Invalid when profit is negative**: When a company is in loss, P/E cannot be calculated at all.

**Ignoring Growth Differences**: A high P/E may correspond to high growth, or it may be a bubble; the ratio alone does not reveal the truth.

**Easily Manipulated**: Companies can make profits look more attractive by changing accounting methods.

**Narrow Perspective**: P/E does not reflect debt situation, cash flow quality, or other key financial factors.

Therefore, when using P/E, don't just focus on this one number; also consider multi-dimensional data such as revenue, profit margin, and corporate leverage.

### There are significant industry differences, and you need to find a benchmark.

The P/E fluctuations in different industries are significant, why is that? Because the risks and growth expectations vary.

**The technology industry** usually has a higher P/E ratio because investors value its growth potential.

The **utilities** industry has a lower P/E ratio because profits are stable and predictable, with relatively slow growth.

If you compare the P/E of a tech company with that of a utility company, you will draw completely incorrect conclusions.

### Can encrypted assets use P/E?

This is a common question. The answer is: **usually not**.

The P/E ratio is designed for companies with clear profit statements. However, most crypto assets do not have financial reports like companies, so the P/E ratio is not applicable.

**But DeFi is different**. Some DeFi platforms charge fees from user transactions and lending, which are similar to corporate profits. Therefore, analysts are experimenting with indicators similar to P/E ratios to assess the value of DeFi tokens—such as comparing the token price to the platform's annual fee income. These methods are still in the early exploratory stage and have not been widely adopted, but they indicate that financial concepts are adapting to the crypto ecosystem.

### Summary

The P/E ratio is a classic tool for stock valuation, helping investors determine whether a stock is reasonably priced by comparing its price with its earnings potential. Although it is not a perfect indicator and should not be used in isolation, it is very valuable as a starting point. In conjunction with industry background, growth prospects, and other financial metrics, the P/E ratio can become an important reference for your investment decisions.