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How to Tell Whether a Stock Is Cheap or Expensive: P/E, P/S, and Valuation Step by Step
Key takeaways
- The P/E ratio (price-to-earnings) tells you how much you are paying for one unit of annual company earnings — the lower, the cheaper the earnings you are buying.
- The P/S ratio (price-to-sales) is useful for companies without profits or for comparisons within an industry.
- Valuation alone does not determine when a stock will rise — a cheap stock can be cheap for good reason (value trap).
- Always compare within the same sector: the P/E of a technology firm and a bank are not comparable.
- The absolute level of P/E is not enough — also track the company's historical average and sector context.
The P/E ratio (price-to-earnings) is the most widely used metric for valuing stocks — it tells you how much you are paying for every unit of the company's annual earnings. Together with P/S (price-to-sales) it gives you a quick map of whether a stock is in "expensive" or "cheap" territory.
How to read the P/E ratio
The formula is simple: P/E = share price / earnings per share (EPS). If the share price is €50 and annual earnings per share are €2.50, P/E is 20. That means: you are paying €20 for every €1 of annual earnings. The historical average of the S&P 500 is around 16–17. In recent years it has moved toward 20–22, pushed higher by technology companies in the index.
- P/E below 10 → the market values the company cheaply (or doubts its earnings)
- P/E 15–20 → historically the "average" range for the equity market
- P/E above 30 → the market expects high growth or is paying for a prestigious brand
When to use the P/S ratio
P/S = share price / revenue per share. P/S is useful where a company has no profit yet — typically fast-growing technology companies or post-IPO startups. You are comparing how much you pay for each unit of revenue. Disadvantage: it ignores profitability — a company with high revenue but massive losses can have a low P/S and still be a poor investment.
Value trap: the cheap stock that stays cheap
A low P/E does not automatically mean an opportunity. A value trap is a situation where a company is cheap for good reason — a declining business, structural problems, or approaching insolvency. Kodak had a very low P/E before its collapse. That is why you should always add this question to any P/E analysis: why is the company valued this way? Is the reason temporary (a bad quarter) or structural (a dying industry)?
Where to find the numbers for free
Current P/E and P/S figures are available free of charge on sites such as Macrotrends, Yahoo Finance, or directly in the stock detail at your broker. For sector comparison Finviz provides useful context. Want to compare the valuation of a specific ETF? Go to the ETF overview or use the company analyses section.
FAQ
What P/E is "good"?
It depends on the sector and historical context. The historical average of the S&P 500 is around 16–17. Technology tends to be higher; banks and utilities lower. A good P/E is one that is lower than the company's or sector's historical average — not an absolute number.
Why is P/S better than P/E for startups?
Startups lack earnings (EPS is negative or zero), so P/E cannot be calculated meaningfully. P/S compares market capitalisation with revenue — those numbers are always positive and allow at least a basic comparison within the sector.
What is forward P/E?
Forward P/E uses estimated next-year earnings instead of historical earnings. It is optimistic, because analyst estimates are systematically too high. It is worth tracking as a supplement, not as the primary metric.