Using the Price/Earnings Ratio to Compare Companies

Introduction

You're comparing companies with the P/E ratio to decide relative value and relative risk, so you need a simple number that links market price to profit. Definition: P/E is the market price per share divided by earnings per share (EPS) - price / EPS - so if a stock trades at $50 and FY2025 EPS is $5, P/E = 10. One-liner takeaway: P/E summarizes how much the market pays for one dollar of earnings. Next: pull the current share price and FY2025 diluted EPS for each company, rank by P/E, and you: flag P/Es above the industry median for further risk checks - defintely check growth and margin assumptions.

Key Takeaways

• P/E shows how much the market pays for one dollar of earnings-Price / FY2025 EPS.
• Pick the right P/E: trailing for realized performance, forward for expected growth; adjust for one-offs.
• Always compare within the same sector/lifecycle-use industry-adjusted P/E or PEG for growth companies.
• Clean the EPS (adjust for buybacks, dilution, non-recurring items) or use cash earnings if distorted.
• Use P/E as a screening flag-compute Price/EPS, compare to peer median, then validate with growth, margins, leverage and other multiples.

Types of P/E and which to use

Trailing P/E - use for realized performance

You're comparing companies on what they actually delivered last year, so start with trailing P/E (price divided by last 12 months earnings per share).

Steps to compute and validate:

• Get the market price (most recent close) and the company's reported FY2025 diluted EPS from the 10-K or earnings release.
• Compute P/E = Price / FY2025 EPS. Example math: Price $120, FY2025 EPS $6.00 → trailing P/E = 20.0x.
• Confirm EPS is final FY2025 and not pro forma; use GAAP EPS if you want raw historic performance, or adjusted EPS if you need cleaned numbers (see adjusted section).
• Check share-count changes: if buybacks materially reduced shares, confirm EPS isn't inflated by one-off capital actions.

Best practices and cautions:

• Compare trailing P/E only to peers with the same fiscal year cadence.
• Use median trailing P/E for the peer set to avoid outlier bias.
• If FY2025 included big one-offs, trailing P/E will mislead; switch to adjusted P/E in that case.

One-liner takeaway: pick trailing for realized performance - it shows what the market paid for the earnings that actually happened. (quick math above.)

Forward P/E - use for expected growth

You want the market's expectation of future profit, so use forward P/E = Price / consensus FY2026 EPS estimate.

Steps and checks:

• Pull consensus FY2026 EPS from FactSet, Refinitiv/ESG, Bloomberg, or reliable public aggregates like Yahoo Finance; note the date and data provider.
• Compute forward P/E. Example math: Price $120, consensus FY2026 EPS $7.50 → forward P/E = 16.0x.
• Measure analyst dispersion: capture high, low, and standard deviation of FY2026 EPS estimates.
• Calculate analyst variance: (High - Low) / Consensus. If variance > 30%, treat forward P/E as high-uncertainty.

Best practices and cautions:

• Prefer forward when comparing growth stories, M&A plans, or management guidance-driven turns.
• Watch timing: use the same cutoff for all peers (e.g., estimates as of 30-Nov-2025).
• Stress-test with upside/downside scenarios: use consensus ± 20% to see P/E range.

One-liner takeaway: pick forward for expected growth - but check analyst variance and scenario P/Es before acting.

Adjusted P/E - use when one-offs distort comparability

You need apples-to-apples EPS across firms, so normalize earnings to remove transitory items and accounting quirks.

Practical adjustment steps:

• Start with FY2025 GAAP EPS and reconciled adjusted EPS from the company's filings; list adjustments (asset sales, restructures, tax items).
• Remove recurring vs non-recurring carefully: treat recurring restructuring as ongoing only if management signals continuation.
• Recalculate adjusted EPS per share: Adjusted net income / diluted weighted-average shares outstanding.
• Compute adjusted P/E = Price / adjusted FY2025 EPS. Example: Price $120, GAAP EPS $6.00, remove one-time gain $1.00 per share → adjusted EPS $5.00 → adjusted P/E = 24.0x.

Best practices and caveats:

• Document each adjustment and its rationale; investors often disagree on what's truly non-recurring.
• Use cash-based alternatives like operating cash flow per share if accruals look aggressive.
• Flag adjustments that materially change valuation - they need governance scrutiny.

One-liner takeaway: pick adjusted P/E when FY2025 had distortions - clean EPS first, then trust the P/E. defintely document assumptions.

Sector and lifecycle context

Compare within the same industry-median P/E varies widely by sector

You're comparing companies across an industry, so start by benchmarking against the industry median P/E rather than the whole market. Different sectors have different typical P/Es because growth, capital intensity, and cash conversion differ.

Practical steps:

• Pull FY2025 EPS for a 10-15 company peer set in the same NAICS/IBES sector.
• Compute trailing P/E = Market Price / FY2025 EPS for each peer.
• Find the median P/E and the interquartile range (IQR) to avoid outlier bias.

Example quick math using five peers (FY2025): Peer A price $150, EPS $5.00 → P/E 30; Peer B $60 / $3.00 → 20; Peer C $120 / $8.00 → 15; Peer D $200 / $10.00 → 20; Peer E $40 / $2.00 → 20. Sorted P/Es: 15, 20, 20, 20, 30 → median 20, Q1 ~17.5, Q3 ~25.

Best practice: if your target's P/E is above the peer Q3, flag growth or risk drivers before concluding it's expensive. Next step: build the 10-15 peer list and compute medians; Owner: you or the equity team.

One-liner takeaway: sector context turns raw P/E into useful signal.

Use industry-adjusted P/E or PEG (P/E-to-growth) for growth companies

If peers grow at different rates, P/E alone misleads. Use an industry-adjusted P/E (P/E divided by sector median P/E) or the PEG ratio (P/E divided by expected EPS growth rate) to standardize across growth profiles.

Practical steps and formulas:

• Calculate industry-adjusted P/E = Company P/E / Industry median P/E.
• Calculate PEG = Company P/E / FY2026 EPS growth % (use percent as whole number, e.g., 15 for 15%).
• Use consensus FY2026 growth from sell-side or a trimmed mean to avoid outliers.

Example: Company X trailing P/E = 30, consensus FY2026 EPS growth = 15% → PEG = 30 / 15 = 2.0. Interpretation: a PEG > 1.0 often implies price outruns growth; PEG 1.0 implies cheap relative growth, but check quality. What this estimate hides: one analyst's 15% could be driven by a single model-check variance across analysts.

Best practice: use PEG only with reliable growth estimates and pair it with cash metrics (FCF yield) and margin durability tests.

One-liner takeaway: sector-adjusted ratios help you compare fast growers with steady growers fairly.

Account for lifecycle: early-stage firms have higher P/Es; cyclicals show volatile P/Es

Company lifecycle matters. Early-stage growth firms typically have high or even negative P/Es (if EPS is tiny/negative) because investors price future expansion. Cyclicals (materials, industrials, autos) swing P/Es across the cycle-high at troughs and low at peaks. Defensive sectors (utilities, consumer staples) usually have lower but steadier P/Es.

How to adjust for lifecycle:

• Classify the company as early-growth, mature, or cyclical before benchmarking.
• For early-growth: prefer forward P/E and PEG using FY2026 consensus; check revenue growth, gross margin trend, and cash runway.
• For cyclicals: normalize earnings with a 3-5 year average or use EV/EBITDA to reduce EPS distortion.
• For mature/defensive: emphasize dividend yield, payout ratio, and leverage alongside P/E.

Example: a cyclical firm with FY2025 EPS suppressed by a downturn posts a trailing P/E of 8 but a 5-year normalized P/E of 18. Do the math: normalized EPS = average FY2021-FY2025 EPS, then compute normalized P/E = Price / normalized EPS. If normalized P/E aligns with peers, the low trailing P/E was a cycle effect, not a structural discount.

Best practice: explicitly document lifecycle classification and use the matching P/E variant (trailing, forward, normalized) so you compare apples to apples. One-liner takeaway: sector context turns raw P/E into useful signal.

Earnings quality and accounting adjustments

You're deciding whether FY2025-based P/E numbers reflect real earning power or accounting noise; start by comparing adjusted EPS to GAAP EPS, then adjust for capital actions and consider cash-based earnings. Clean the EPS before you trust the P/E.

Check FY2025 adjusted EPS versus GAAP EPS to spot one-offs

Start with the company's FY2025 reported GAAP EPS and the management or consensus adjusted EPS (non-GAAP). Look for large gaps: if adjusted EPS > GAAP EPS by more than 20%, dig into the notes. One-time items (asset sales, restructuring, litigation gains/losses) often create that gap.

Practical steps:

• Pull FY2025 GAAP EPS from the 10-K or FY report.
• Pull the company's FY2025 adjusted EPS from the earnings release or 8-K reconciliations.
• List line items removed to get adjusted EPS and quantify each after tax.

Here's the quick math: if GAAP EPS = $1.20 and adjusted EPS = $1.60, one-offs net to $0.40 per share. What this estimate hides: timing/tax treatments and recurring nature - reclassify recurring adjustments back into core EPS.

One-liner takeaway: verify every big adjustment in the footnotes; don't accept adjusted EPS at face value.

Adjust for share buybacks, dilution, and non-recurring gains or losses

EPS is per-share; changes in shares materially alter P/E. For FY2025, reconcile diluted shares outstanding to the period-end share count and model the effect of buybacks or issuances on FY2025 EPS pro forma. Buybacks reduce shares and mechanically raise EPS even if operating profits are flat.

• Get weighted-average diluted shares for FY2025 (from the income statement).
• Get period-end shares and total buybacks/issuances in FY2025 (cash spent and shares retired).
• Compute pro forma EPS assuming buybacks executed evenly: Pro forma EPS = (Reported Net Income) / (Weighted diluted shares - Average shares retired).

Example: reported net income = $500m, diluted shares = 250m → GAAP EPS = $2.00. If buybacks retired 20m shares, pro forma EPS = $500m / 230m = $2.17. Do the same for dilution from stock comp and convertible instruments.

Adjust for non-recurring gains/losses by removing their after-tax effect from net income before dividing by the adjusted share base. One-liner takeaway: undo capital-action math before you act on the P/E.

Use cash earnings (operating cash flow per share) if earnings are distorted

If accruals, large non-cash items, or aggressive revenue recognition distort FY2025 EPS, substitute or triangulate using cash-based measures: operating cash flow per share (OCFPS) or free cash flow per share (FCFPS). These show cash generated per share and reduce accounting-policy noise.

• Compute FY2025 OCFPS = Operating cash flow (FY2025) / Weighted-average diluted shares.
• Compute FY2025 FCFPS = (Operating cash flow - CapEx) / Weighted-average diluted shares.
• Compare OCFPS or FCFPS-derived P/E equivalent: Price / OCFPS or Price / FCFPS, noting these are cash multiples not true P/Es.

Example quick math: operating cash flow = $600m, CapEx = $150m, diluted shares = 250m → FCFPS = ($600m - $150m) / 250m = $1.80. If market price = $36, cash-based multiple = 36 / 1.80 = 20x. What this hides: temporary working-capital swings and timing of CapEx; smooth over 3 years if volatile.

One-liner takeaway: use cash-per-share as a sanity check when EPS looks engineered or volatile.

Next step: Finance - produce a reconciled FY2025 EPS table (GAAP, adjusted items with after-tax amounts, weighted shares, pro forma EPS, OCFPS, FCFPS) for five peers by Wednesday; I'll review the adjustments.

Valuation comparatives and multiples framework

Build a comps table: Price, FY2025 EPS, trailing P/E, forward P/E, EV/EBITDA

You're assembling a peer table to compare valuation across similar firms; start by collecting market price, FY2025 EPS (GAAP and adjusted), consensus FY2026 EPS, shares outstanding, net debt, and FY2025 EBITDA.

Follow these practical steps:

• Pull Market Price from the exchange feed
• Use FY2025 EPS (adjusted first, GAAP second)
• Compute Trailing P/E = Price / FY2025 EPS
• Use consensus FY2026 EPS for Forward P/E
• Compute Enterprise Value = Market Cap + Net Debt
• Compute EV/EBITDA = Enterprise Value / FY2025 EBITDA

Use this compact table template and populate for 5-10 peers; keep adjusted EPS and GAAP EPS side-by-side. Example (illustrative only):

One-liner takeaway: build a single row per peer with Price, FY2025 EPS, trailing and forward P/E, and EV/EBITDA to compare apples-to-apples.

Use median and interquartile P/E to avoid outlier bias

Raw averages lie when one or two high-growth names skew the mean; use the median and interquartile range (IQR) to get a robust central view. Do this before you label a stock cheap or expensive.

Practical checklist:

• Compute each peer trailing P/E using FY2025 EPS
• Sort P/Es and take the median (50th percentile)
• Compute 25th and 75th percentiles for the IQR
• Flag peers outside 1.5× IQR as outliers
• Use median P/E for portfolio-level signals

Quick math example: peer P/Es = [8, 12, 15, 20, 50]; median = 15x, IQR = 12-20x. If a company sits at 20x, it's at the 75th percentile, not automatically overvalued - check drivers.

What this hides: median ignores structural differences (growth, margins); always segment by industry and margin buckets first. A defintely high P/E in a growth cohort is different from one in mature industrials.

One-liner takeaway: use median and IQR to see where a company truly sits in its peer group.

Translate P/E into implied growth or discount to peer median for action

P/E is a price for earnings; you can convert it into an implied growth premium or a percentage discount versus peers to guide decisions. Two practical methods work well: PEG and earnings-yield based implied growth.

Steps and formulas:

• PEG = P/E / (FY2025-FY2026 EPS % growth)
• Earnings yield = EPS / Price = 1 / P/E
• Implied growth (Gordon-style) = Cost of equity (r) - Earnings yield
• Discount to peer median = (Peer median P/E - Company P/E) / Peer median P/E

Examples (illustrative):

If Company P/E = 20x and FY2025→FY2026 EPS growth = 25%, PEG = 20 / 25 = 0.8 (cheap for growth). If peer median P/E = 15x, Company trades at a (20-15)/15 = 33% premium.

For implied growth: if P/E = 20x, earnings yield = 5%. With a chosen cost of equity r = 9%, implied long-term growth g = 9% - 5% = 4%. Use sensitivity: if r moves to 10%, g falls to 5% - 1% = 3%.

Decision rules you can apply:

• If premium > 25%, demand evidence of superior FY2026 growth and durable margins
• If PEG < 1 and quality metrics strong, consider accumulation
• If implied growth below long-term consensus, treat the premium skeptically

One-liner takeaway: P/E is a flag-confirm with EV/EBITDA, margins, and cash metrics before you act.

Next step: you (or your team) should populate a 5-company comps table with Market Price, FY2025 Adjusted EPS, Trailing and Forward P/E, EV, and FY2025 EBITDA by Friday; Finance: own the table and data pulls.

Practical steps and quick math

You're comparing companies with P/E to decide relative value and risk; compute P/E from market price and FY2025 EPS, compare to peers and sector medians, then investigate why numbers differ. Quick takeaway: do the math, then validate the drivers behind the number.

Get Market Price and FY2025 EPS, then compute P/E

Start with a clean price and a clean EPS. Use the last traded share price (or 30‑day average to smooth volatility) and FY2025 diluted EPS or adjusted EPS (remove one‑offs). Use diluted EPS to reflect share count after options and convertible effects.

Formula: P/E = Market price per share / FY2025 EPS.

Example math: if Market price = $62.50 and FY2025 adjusted EPS = $3.75, then P/E = 16.7 (62.50 / 3.75 = 16.667). What this hides: buybacks lower shares outstanding and raise EPS; large one‑time gains inflate GAAP EPS-adjust first or use non‑GAAP EPS.

Practical checks:

• Pull price at a set time (close, 30‑day average)
• Use FY2025 adjusted diluted EPS from the 10‑K or consensus data
• Note share count changes; recompute EPS if buybacks materially changed denominator

One-liner takeaway: compute trailing P/E with FY2025 EPS, and prefer adjusted diluted EPS when available.

Compare to peer median P/E and sector median; note percentile rank

Place your P/E in context. Build a comps table (Price, FY2025 EPS, trailing P/E, forward P/E) for 5-12 close peers and the sector index. Use median and interquartile range to avoid outlier bias.

Example comp set P/Es: 12.5, 15.0, 16.7 (your company), 22.0, 30.0. Median = 16.7; interquartile range = 13.75-26.0. Your percentile: 50th.

Best practices:

• Match business model and margins when picking peers
• Use sector median from an index provider (or S&P/GICS subgroup)
• Compute percentile rank: (number of peers with P/E below yours) / (total peers)
• Prefer median over mean; report IQR to show dispersion

One-liner takeaway: sector context turns raw P/E into a useful signal-percentiles matter more than raw decimals.

If P/E is much higher than peers, check growth, margin durability, and balance sheet leverage

A high P/E can mean high expected growth, cleaner earnings, or overexuberance. Run three validation checks: growth vs. consensus, margin quality, and leverage/coverage.

Growth check: get consensus FY2026 EPS growth rate (or 3‑yr EPS CAGR). Compute PEG = P/E / (EPS growth %). Example: P/E = 40, consensus FY2026 EPS growth = 25% → PEG = 1.6. Interpretation: PEG ~1 is fair for steady growth; >1.5 needs strong margin durability.

Margin and durability check:

• Compare FY2025 gross and operating margins to peers
• Ask if margins are cyclical, scale‑driven, or one‑time (e.g., cost cuts)
• Prefer companies with stable or expanding operating margins

Leverage and cash quality check:

• Compute net debt / EBITDA. Red flags: > 3.0x for cyclical firms, > 4-5x for midcaps (depends on sector)
• Check interest coverage: EBIT / interest expense; <3x = higher risk
• Compare operating cash flow per share to EPS; wide divergence signals accounting distortion

Example red‑flag scenario: P/E = 40, peer median = 16.7, consensus growth = 10% → PEG = 4.0 (expensive unless margins or ROIC justify it). If net debt = $2.5B and EBITDA = $500M, net debt/EBITDA = 5.0x-that raises solvency risk.

One-liner takeaway: do the math, then validate whether growth, margins, and leverage justify the premium-or it's likely a valuation gap you shouldn't pay for.

Next step: you: build a 5‑company comps table using FY2025 EPS and forward FY2026 estimates; Finance: produce the table and percentile ranks by Friday.

Using the Price/Earnings Ratio to Compare Companies - Final actions

You're using P/E to separate cheap from expensive names and to flag risk. Here's a tight, action-first close: treat P/E as a screening tool, clean the earnings, and then run a five-company comps table using FY2025 EPS and forward estimates so you can act.

Use P/E as a starting filter, not the final verdict

Start by screening with P/E to reduce your universe quickly. For example, filter out names above the 90th percentile and below the 10th percentile inside the same industry - those are outliers that need specific explanations (growth, accounting, distress). Don't buy or sell on P/E alone; use it to pick 5-15 candidates for deeper work.

Practical steps:

• Pull trailing P/E using FY2025 EPS for all peers
• Compute percentile ranks inside the sector
• Flag names >75th or <25th percentile for review
• Exclude firms with negative FY2025 EPS from P/E ranking

One-liner takeaway: P/E narrows the field fast, but it's only a flag - not the answer.

Combine FY2025 EPS-based P/E with growth, cash metrics, and accounting checks

After the screen, clean the earnings. Compare FY2025 GAAP EPS to adjusted EPS reported in the 10‑K or earnings release; note one-offs, restructuring, or tax items. Convert large share-buybacks into per-share effects: if buybacks reduced shares outstanding by 5%, adjust EPS to see the organic change. Use operating cash flow per share and free cash flow per share if GAAP earnings look engineered.

Quick math example (example only): if Price = $60, FY2025 EPS = $3.00 then trailing P/E = 20x. If consensus FY2026 EPS = $3.60, forward P/E = 16.7x and implied EPS growth = 20% - PEG = 1.0. What this hides: one-time tax benefits or aggressive revenue recognition can make that growth look better than it is. Always cross-check with cash flow and balance-sheet leverage (net debt / EBITDA).

One-liner takeaway: clean the EPS and pair P/E with growth and cash to avoid false bargains.

Next step: run a 5-company comps table using FY2025 EPS and forward estimates

Build a tight comps table with these columns: Ticker, Market Price (valuation date), FY2025 EPS (actual), Trailing P/E, FY2026 Consensus EPS, Forward P/E, EV/EBITDA, Net Debt / EBITDA, and Analyst Coverage Count. Use the same valuation date for all prices (e.g., market close on your chosen date) and disclose the date clearly.

Template and actions:

• Source EPS and estimates from filings and consensus data
• Compute trailing P/E = Price / FY2025 EPS
• Compute forward P/E = Price / FY2026 EPS estimate
• Calculate median and IQR P/E for the five names
• Note each company's percentile vs peer median

Example table header (fill with FY2025 data):

One-liner takeaway: run a compact, date-stamped comps table, then explain any P/E gaps with growth, margins, or leverage - defintely don't skip that step.

Next step and owner: Equity Analyst - prepare the 5-company comps table (FY2025 & FY2026) and deliver by Friday, including sources and a one-paragraph rationale per name.