The Price-to-Earnings ratio (P/E) is the most widely used valuation metric in investing. It answers a simple question: how much are you paying for each dollar of a company's earnings? You calculate it by dividing the stock price by the earnings per share (EPS). If a stock trades at $100 and earns $5 per share, it has a P/E of 20. That means investors are willing to pay $20 for every $1 of earnings. A lower P/E generally means a stock is cheaper relative to its earnings; a higher P/E means you're paying a premium. But cheap and expensive are relative — context matters more than the raw number.

There are two flavors of P/E you need to know. Trailing P/E uses the last 12 months of actual reported earnings — it's backward-looking and based on real numbers. Forward P/E uses analyst estimates for the next 12 months of expected earnings — it's forward-looking and based on projections. Forward P/E is what most professional investors focus on because stocks are priced on future expectations, not past results. A company with a trailing P/E of 30 might have a forward P/E of 20 if earnings are expected to grow 50% — that changes the picture entirely. Always check which P/E version you're looking at.

The biggest mistake beginners make is using P/E in a vacuum. A P/E of 25 means nothing without context. You need to compare it to the stock's historical P/E (is it above or below its own average?), the sector average (tech stocks typically trade at higher P/Es than utility stocks because they grow faster), and the overall market (the S&P 500 historically averages around 15-17x trailing earnings). A stock with a P/E of 35 might be a bargain if its sector averages 40 and the company is growing faster than its peers. Conversely, a P/E of 10 could be a value trap if earnings are about to collapse.

Beyond P/E, other valuation ratios fill in the picture. The PEG ratio (P/E divided by earnings growth rate) adjusts for growth — a PEG of 1.0 means the P/E equals the growth rate, which is generally considered fair value. Price-to-Sales (P/S) is useful for companies that don't yet have earnings (common in tech). Price-to-Book (P/B) compares the stock price to the company's net asset value — useful for banks and asset-heavy industries. No single ratio tells the whole story. Professional investors use multiple valuation metrics together to build a complete picture of whether a stock is overvalued, fairly valued, or undervalued relative to what it's actually worth.