The P/E ratio – A guide to evaluating stocks

The Essentials at a Glance

The price-to-earnings ratio (KGV) is one of the most observed metrics for investors who want to assess stocks. This figure shows how many euros investors spend for every euro of company profit – a direct indicator of over- or undervaluation. The correct interpretation of the P/E ratio heavily depends on the industry context and the company's growth prospects.

There are several variants of this metric – from historical to expected P/E ratios – each with its own nuances. It's important to know: The classical P/E concept does not work for cryptocurrencies, but alternative valuation methods are now emerging in the DeFi sector.

What is the KGV about exactly?

The price-to-earnings ratio (KGV) represents the relationship between the current stock price and the earnings generated. Specifically, the price is divided by the earnings per share – the result indicates how expensive or cheap a stock is valued.

For investors, this ratio provides quick guidance: A higher P/E ratio indicates that market participants are pricing in future growth. A low P/E ratio may suggest undervaluation – or it may warn of risks that the market has already taken into account.

This is how the P/E ratio is calculated

The formula is simple: P/E Ratio = Stock Price ÷ Earnings per Share (EPS)

The EPS value is determined by dividing the annual profit ( after taxes and preferred dividends ) by the total number of outstanding common shares. This calculation immediately reveals whether the market price of a stock appears justified.

The Different Types of KGV

Historical P/E Ratio – The Retrospective

The so-called trailing P/E ratio is based on the earnings numbers of the past twelve months. This is the most commonly cited variant, as it is based on real, already occurred results and contains less speculation.

Future-oriented P/E ratio – A look ahead

The forward P/E ratio uses earnings forecasts for the coming twelve months. Analysts create these estimates based on trend analyses and company outlooks. This P/E ratio can be more aggressive if market growth is anticipated.

Absolutes vs. Relatives P/E Ratio

The absolute P/E ratio is the direct application of the fundamental formula. The relative P/E ratio, on the other hand, compares the current P/E ratio to benchmark values – such as the historical average of the company or the industry average.

KGV Interpretation – The context makes it

The correct interpretation of the P/E ratio requires expertise and industry knowledge. A high P/E ratio is not automatically bad – it can be legitimate if the company has significant growth potential. Conversely, a low P/E ratio could indicate attractive entry opportunities or warn of business risks.

Industries differ significantly: Technology companies are traded at significantly higher P/E ratios than utilities – because investors expect faster growth there. A comparison across sector boundaries is therefore problematic and often leads to false conclusions.

When is the P/E ratio the most meaningful?

The P/E ratio provides its greatest utility in the following scenarios:

Stock Screening: Through systematic P/E ratio analyses, potentially undervalued securities can be identified. Those who specifically look for stocks with lower P/E ratios than the industry average often find interesting candidates.

Historical Comparison: How has a company's P/E ratio developed over time? Rising P/E ratios may indicate growing expectations – or increasing skepticism with falling P/E ratios.

Industry Comparisons: Within the same sector, differences in P/E ratios quickly reveal which stocks are valued more cheaply or expensively. This allows for an assessment of whether premiums appear justified due to superior management or other factors.

The weaknesses of this metric

Despite their prevalence, the KGV ratio has notable limitations:

In case of losses useless: If a company incurs losses, the P/E ratio is not meaningful – it cannot be calculated or misunderstood.

Growth not fully represented: The P/E ratio is usually based on current or historical earnings. Future growth potential is only implicitly reflected in the market valuation, not directly in the metric itself.

Creative accounting distorts reality: Companies can influence their reported profits through legal accounting practices. A high or low P/E ratio could therefore be based on inflated figures.

Incomplete Picture: The P/E ratio does not take into account debt levels, cash flow, or other fundamental indicators. A solid analysis therefore always combines the P/E ratio with revenue growth, profit margins, and debt ratios.

Industry Dynamics and P/E Ratio Differences

The P/E ratios differ significantly depending on the industry sector. Therefore, a direct comparison only makes sense within the same industry.

Technology companies typically have higher P/E ratios because investors price in exponential growth there. A tech corporation with a P/E ratio of 40 or 50 is by no means overpriced – that is typical for the market.

Utility companies, on the other hand, usually show low P/E ratios between 10 and 15. Their stable, predictable cash flows lead to more moderate valuations. A P/E ratio of 30 would be a red flag here.

Those who ignore these differences come to misguided conclusions.

P/E Ratio and Cryptocurrencies – A Difficult Relationship

The application of the P/E ratio to Bitcoin, Ethereum, or other cryptocurrencies is not possible. The reason is fundamental: cryptocurrencies do not generate company profits, do not produce annual reports, and do not have a balance sheet like publicly traded companies.

However, there are exceptions in the DeFi ecosystem. Some decentralized finance platforms generate fee revenues and are partially analyzed with comparable metrics – for example, by relating the token price to the protocol revenues. These approaches are still in the experimental stage and have not yet been standardized.

They show, however, that traditional financial metrics are also being gradually adapted in the cryptocurrency world.

Conclusion – An indispensable but not sufficient tool

The price-to-earnings ratio remains one of the most important tools of fundamental analysis. It provides quick and meaningful insights into the valuation of stocks. However, the correct interpretation of the P/E ratio is dependent on industry knowledge and contextual understanding.

Anyone looking to use the P/E ratio should not consider it in isolation but always combine it with other indicators – revenue development, profit margins, debt ratios, and cash flow metrics are included. Only then does a solid investment picture emerge.