Master the Price-to-Earnings Ratio calculation to unlock the secrets of stock valuation

In the world of stock investing, the Price-to-Earnings (PE) ratio is an indispensable indicator for evaluating a company’s value. Investors often hear analysts mention a company’s historical PE, current PE, and the calculation of fair value, but many still have only a superficial understanding of this metric. This article will delve into various methods of calculating the PE ratio, helping you understand this valuation tool from scratch.

The Core Definition of the PE Ratio

The PE ratio (also known as PER, or Price-to-Earnings Ratio), is a key indicator for assessing whether a stock price is reasonable. It answers a simple yet profound question: how many years will it take to recover your investment through the company’s profits at the current stock price?

For example, TSMC’s PE ratio is 13, meaning that at the current stock price, it would take 13 years of the company’s earnings to fully recover the investment. The lower the PE ratio, the cheaper the stock; the higher the PE, the higher the market’s valuation, usually reflecting optimistic expectations for the company’s future growth.

Two Basic Methods of Calculating the PE Ratio

Although calculating the PE ratio may seem complex, fundamentally it only requires mastering two formulas:

Method 1: Stock Price ÷ Earnings Per Share (EPS)

This is the most common way to calculate the PE ratio. For example, if TSMC’s current stock price is NT$520 and its EPS for 2022 is NT$39.2, then PE = 520 ÷ 39.2 ≈ 13.3 times.

Method 2: Company Market Value ÷ Net Income Attributable to Common Shareholders

This method considers the entire company’s valuation and yields the same result as Method 1.

Understanding Three Types of PE Ratios in Depth

The source of EPS data used in PE calculations varies, resulting in three different types, each suitable for different scenarios.

Static PE Ratio: Based on Known Data

Calculation formula: Stock Price ÷ Annual EPS

The static PE ratio uses the company’s publicly announced annual earnings data. For example, TSMC’s 2022 annual EPS is calculated as Q1 + Q2 + Q3 + Q4 = 7.82 + 9.14 + 10.83 + 11.41 = NT$39.2. Since the annual EPS remains unchanged before the new year’s report is released, the PE ratio’s fluctuation depends entirely on stock price movements, hence called “static.”

The advantage of the static PE ratio is that the data is clear and reliable; its disadvantage is lagging, as it cannot reflect the latest profit situation in real-time.

Rolling PE Ratio: Tracks the Latest 12 Months’ Dynamic Data

Calculation formula: Stock Price ÷ Sum of EPS over the Latest 4 Quarters

The rolling PE ratio (TTM, Trailing Twelve Months) uses the most recent quarterly financial reports. Suppose TSMC reports EPS of NT$5 in Q1 2023, then the latest 4-quarter EPS is 9.14 + 10.83 + 11.41 + 5 = NT$36.38, and PE (TTM) = 520 ÷ 36.38 ≈ 14.3 times.

This method overcomes the lag of the static PE ratio and can more timely reflect the company’s earnings trend.

Dynamic PE Ratio: Future Forecast-Based Valuation

Calculation formula: Stock Price ÷ Estimated Annual EPS

The dynamic PE ratio is based on forecasts of future earnings by various institutions. For example, if analysts estimate TSMC’s 2023 EPS to be NT$35, then the dynamic PE = 520 ÷ 35 ≈ 14.9 times.

However, different institutions’ estimates vary, and forecast accuracy is uncertain, which can cause confusion among investors. Therefore, its practical use is somewhat limited.

How to Judge the Reasonableness of a PE Ratio

Obtaining the PE value is just the first step; the key is to determine whether this multiple is high or low. Common evaluation methods include two approaches.

Peer Comparison Method

PE ratios vary greatly across industries. According to Taiwan Stock Exchange data from February 2023, the PE of automotive industry stocks can reach as high as 98.3, while shipping industry stocks have a PE as low as 1.8. Therefore, comparisons should only be made within the same industry, preferably among companies with similar business models.

For example, TSMC can be compared with UMC and Powertech. As of December 5, 2025, TSMC’s PE is approximately 23.85, UMC’s PE is about 15. In comparison, TSMC’s higher PE reflects the market’s higher expectations for its future prospects.

Historical Trend Comparison

By comparing the current PE with the company’s historical PE, you can judge whether the stock is overvalued or undervalued. Currently, TSMC’s PE is 23.85, which is in the upper-middle range of its five-year history, neither at a bubble peak nor significantly below recession lows, indicating a healthy rebound after economic improvement.

Practical Application of the PE Ratio

The Utility of the PE River Chart

The PE river chart visualizes the PE calculation results. The chart typically displays 5 to 6 curves based on the formula “Stock Price = EPS × PE.” The top line represents the historical highest PE corresponding stock price, and the bottom line shows the lowest PE’s corresponding stock price.

By observing where the current stock price lies within the river chart, investors can intuitively judge whether the stock is overvalued or undervalued. If the price is in the lower region, it usually indicates undervaluation and a potential buying opportunity; if in the upper region, there may be a risk of correction.

The Dialectical Relationship Between PE and Stock Price Movements

It is important to note that, a low PE ratio does not necessarily mean the stock price will rise, nor does a high PE mean it will fall. The market’s willingness to assign high valuations to certain companies often stems from investors’ optimism about their future development prospects. Tech stocks generally have higher PE ratios, yet their prices continue to rise, exemplifying this phenomenon.

Limitations and Cautions in Using the PE Ratio

Ignores Corporate Debt Structure

The PE ratio only focuses on equity profits and ignores the company’s debt situation. Two companies with the same PE may have vastly different risks if one has low debt and the other high debt. When facing economic adjustments or rising interest rates, highly leveraged companies are at greater risk.

Difficult to Define High or Low Standards Accurately

A high PE may result from temporary pressure but strong fundamentals, with the market willing to hold; or from expectations of significant future earnings growth, with the market preemptively positioning; or simply from short-term overvaluation needing correction. These situations are difficult to judge solely based on historical experience and require in-depth fundamental analysis.

Cannot Evaluate Non-Profit Companies

Many startups and biotech firms have no profits yet, making PE calculation impossible. In such cases, investors should turn to other valuation metrics, such as Price-to-Book (PB) and Price-to-Sales (PS).

Comparing the PE Ratio with Other Valuation Metrics

Mastering the calculation methods and application scenarios of the PE ratio is an important step toward becoming a savvy investor. Whether using static, rolling, or dynamic methods, the key is to combine industry comparisons and historical trends to rationally evaluate stock value and avoid being swayed by short-term market emotions.