Understanding P/E Ratios and Other Valuation Metrics: What “Cheap” and “Expensive” Actually Mean

“The market is expensive” gets said constantly, almost always in reference to the P/E ratio — but a single number, calculated a few different ways, is being asked to summarize a lot more than it can actually tell you on its own.

Trailing P/E, Forward P/E, and Why They Diverge

The basic price-to-earnings ratio divides a stock’s price by its earnings per share. Trailing P/E uses the past twelve months of actual reported earnings; forward P/E uses analysts’ earnings estimates for the next twelve months. As of mid-2026, the S&P 500’s trailing P/E has been running in the high-20s — meaningfully above its modern-era average of roughly 19–20 — while the forward P/E, in the low-20s, sits closer to (though still above) its 10-year average of about 18.8. The gap between the two numbers reflects how much earnings growth the market is pricing in; when forward P/E is well below trailing P/E, it means analysts expect earnings to grow substantially.

Why a Low P/E Isn’t Automatically a Bargain

A stock can have a low P/E because the market has correctly identified that its earnings are about to decline, that its industry is being disrupted, or that its earnings quality is poor (unusually low P/E ratios cluster in cyclical and distressed industries for a reason). This is the classic “value trap”: a stock that looks statistically cheap and stays cheap, or gets cheaper, because the low multiple was pricing in a real problem the whole time.

Other Metrics Worth Knowing

The PEG ratio divides the P/E by the expected earnings growth rate, which adjusts for the fact that a fast-growing company deserves a higher P/E than a slow-growing one — a PEG near or below 1 is the traditional rule-of-thumb for reasonably priced growth. Price-to-sales is useful for companies with no current earnings (common among younger growth companies), since it can be calculated even when P/E can’t. None of these metrics work as a standalone buy or sell signal — they’re most useful compared against a company’s own history and against direct industry peers, not as an absolute threshold applied the same way to every stock in every sector.

Written by Samuel, Certified Public Accountant

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