P/E — the Price of a Dollar of Profit

What it says

P/E = price ÷ EPS = how many dollars the market pays for one dollar of yearly profit. P/E 20 = $20 for $1/year of profit = a 5% earnings yield. High P/E = the market expects growth (or is euphoric); low P/E = low expectations (or trouble ahead). Neither is automatically cheap or expensive — P/E is a CLAIM about the future, not a verdict on the present.

Trailing vs forward

Trailing P/E uses the last 12 months (fact, but backward); forward P/E uses next-year ESTIMATES (relevant, but analysts are systematically optimistic — forward P/Es run low). Always know which one a headline is quoting: "cheap at 12×" is a different claim depending on whose earnings.

Context beats level

A "high" P/E is normal for: high-growth, high-ROIC, asset-light businesses. A "low" P/E is normal for: cyclical PEAK earnings (steel at the top of the cycle trades at 6× — the trap), heavily indebted firms, and declining industries. The question is never "is 15 high?" but "what growth, quality and risk does 15 imply, and is that plausible?"

Sources

• Price-to-Earnings RatioInvestopedia
• Berkshire Hathaway Shareholder LettersWarren Buffett