Fundamental analysis · Beginner

Earnings Per Share and the P/E Ratio

Invert the P/E and it becomes an earnings yield you can hold against a government bond. That is the comparison the ratio is actually for.

Last reviewed 15 September 2026 by the MarketPro research desk · Editorial policy

In short

Earnings per share is net profit divided by shares outstanding. The price-to-earnings ratio is the share price divided by earnings per share, showing how much you pay for each unit of annual profit. A P/E of 20 inverts to a 5% earnings yield, which can be compared directly against a government bond yield. Rising interest rates compress P/E ratios arithmetically, with no change in company performance.

What to remember

A P/E of 20 is a 5% earnings yield. Comparing that to the ten-year government bond yield is what the ratio is for.
Buying back 10% of the shares lifts EPS by 11% with profit completely flat, so check the share count before crediting growth to the business.
A forward P/E far below the trailing figure is a claim, not a discount. Estimates are revised down more often than up.
Cyclical companies look cheapest at peak earnings and dearest at the trough, which inverts the usual reading of a low multiple.

Lesson 11 of 24 in Fundamental analysis

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Earnings per share divides a company's net profit by the number of shares outstanding. The price-to-earnings ratio divides the share price by earnings per share. Together they answer one question: how much are you paying for each unit of current profit. What they do not answer is whether that price is sensible, which is where most of the trouble starts.

A £40 share on £2 of earnings

A company earns £500m and has 250m shares, so EPS is £2.00. The share trades at £40, so the P/E is 20. Invert it and you get the earnings yield: 1 divided by 20 is 5%. The company generates 5p of profit a year for every pound you pay.

That inversion is the most useful thing about the ratio, because 5% is directly comparable to a government bond yield. If ten-year gilts yield 4.5%, you are accepting a 0.5 point premium over a government-backed return as the entire payment for growth and for equity risk. If gilts yield 6%, you are paying more for a riskier asset than for a safer one, and the equity needs strong growth to justify it.

This is also why rising interest rates compress P/E ratios across a whole market with no change in company performance. When the return on government debt rises, the earnings yield required from equities rises with it, and a higher required earnings yield is by definition a lower P/E. The move is arithmetic, not sentiment.

Buybacks: growing EPS without growing the business

Take the same company. Net income stays flat at £500m. It spends cash buying back 25m shares, reducing the count from 250m to 225m. EPS becomes £500m divided by 225m, or £2.22, an 11% increase.

The press release will describe double-digit earnings growth. Not one additional unit was sold and not one pound of extra profit was made. Whether this is good or bad depends on the price paid: buying back shares below intrinsic value transfers value to remaining holders, buying back above it destroys value, and many companies buy most heavily when their share price is highest because that is when cash is most abundant.

The check takes seconds. Look at the share count alongside EPS. If EPS is growing and the share count is falling, work out how much of the growth is the denominator before crediting it to the business.

Dilution runs the same mechanism in reverse. A company that issues shares to fund an acquisition, or pays staff heavily in stock, increases the denominator, so EPS can fall while total profit rises. Share-based pay is the version most often overlooked, because it is a real cost to existing holders that never appears as a cash outflow. Comparing profit growth with EPS growth over three years shows immediately which direction the share count has been pulling, and the gap between the two figures is the part of the story the headline leaves out.

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Trailing, forward, and the gap between them

Measure	Uses	Weakness
Trailing P/E	Reported earnings, last 12 months	Describes a period that has ended
Forward P/E	Analyst estimates, next 12 months	Estimates are systematically optimistic early in the year
Shiller P/E	10-year inflation-adjusted average	Too slow for anything but long-horizon comparison

A forward P/E well below the trailing P/E means analysts expect earnings to rise sharply. That may be correct. It is also the position analysts hold most often at the top of a cycle, because estimates are revised down as the year progresses far more often than up. Treat a large trailing-to-forward gap as a claim requiring evidence rather than as a discount.

Why a P/E of 9 is sometimes exactly the right price

Low multiples attract people looking for bargains, and a large share of them are correctly priced warnings. The market applies a low multiple when it expects earnings to fall, when the business is structurally declining, when the balance sheet carries more debt than the equity can support, or when the current earnings are the peak of a cycle.

Cyclical businesses invert the usual reading entirely. A steel producer or a housebuilder looks cheapest at the top of its cycle, when earnings are at maximum, and most expensive at the bottom, when earnings have collapsed but the market is already pricing the recovery. Buying a cyclical on a low P/E is frequently buying peak earnings at a fair price, which is not the same as buying a cheap company.

Using the multiple as a question

A P/E is a starting point for one question: what does the market expect, and do I disagree? A high multiple encodes an expectation of growth. Work out what growth rate would be needed to make the price reasonable, then ask whether the revenue line, the margin trend and the cash generation support it.

Run the same comparison inside a sector rather than across the whole market. A software business and a supermarket carry structurally different multiples for structurally good reasons, and comparing them tells you about the industries, not the companies. Then cross-check with the cash flow statement, because EPS is built on reported profit and reported profit has more discretion in it than cash does. Whatever the multiple ends up saying, it is a view rather than a position, and what you stake on a view is settled by size rather than by how convinced you are.

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Written and reviewed by the MarketPro research desk

MarketPro is a trading-signal and trading-education app operated by Harajuku Holdings LTD (Cyprus). Our signal desk publishes and tracks every trade idea in-app, and every page here is checked against the app's live behaviour before publishing. Last reviewed 15 September 2026. How we produce signals and content · About MarketPro

FAQ

Earnings Per Share and the P/E Ratio: questions

What is a good P/E ratio?

There is no universal figure, because the correct multiple depends on growth, risk and the prevailing level of interest rates. The useful comparisons are against the company's own history, against direct competitors in the same industry, and against the bond yield via the inverted earnings yield. A multiple of 12 can be expensive for a declining business and 30 can be reasonable for one compounding earnings rapidly.

Why do P/E ratios fall when interest rates rise?

Because the return available from safe assets sets the minimum return investors demand from risky ones. If government bonds yield 6%, an equity earnings yield of 5% is unattractive, so the price falls until the earnings yield rises above it. A higher earnings yield is mathematically the same thing as a lower P/E, which is why an entire market can de-rate without any company reporting worse results.

Can a company have a negative P/E ratio?

If earnings are negative the ratio is mathematically negative, but it is usually reported as not meaningful rather than shown, because a negative multiple conveys no information about relative value. For loss-making companies analysts substitute other measures, such as price to sales, enterprise value to revenue, or a forward multiple based on the first year profitability is expected.

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