Financial Key Ratios: Price-to-Earnings

Investors can determine how expensive or cheap a stock is relative to competitors or other available investments by using standardized metrics that enable apples-to-apples comparisons. These metrics are widely used by equity analysts and investors for investment screening and peer benchmarking, providing a starting point for identifying differences in pricing that could later be evaluated by the investor or analyst to determine whether a company is undervalued or overvalued. By standardizing a company's market value against its earnings, sales, assets, or cash flows, these ratios make it easier to compare stocks against each other.

The Price-to-Earnings Ratio: A Closer Look

In this article, we will focus on one of these metrics, the Price-to-Earnings (P/E) ratio, exploring how it is used to assess relative valuation and investor expectations. We examine how P/E ratios vary across geographies and sectors, and how they change over time in response to macroeconomic cycles and shifts in market sentiment. While widely used for its simple and standardized nature, the P/E ratio is most effective when viewed in context, considering factors such as industry characteristics, growth prospects, and long-term historical averages.

The Price-to-Earnings ratio (share price / earnings per share) puts the price of a stock in relation to its annual earnings. The P/E ratio is perhaps the most widely used valuation ratio when it comes to stocks, as it provides a straightforward and standardized measure of investors’ willingness to pay for a company’s earnings at a specific point in time. The ratio reflects investors’ opinions on a company’s ability to turn sustainable and growing profits. This can be measured with explicit metrics such as earnings growth and return on capital, or with more subtle ones, such as a company’s positioning relative to peers. For example, a high P/E in relation to the company’s peers can signal that investors expect the company’s earnings to grow more quickly than its competitors’ earnings, while a low P/E can suggest that the company is struggling. However, as with all metrics, other factors, such as a company’s industry, geography, financial position, and details not specific to the company, play a part as well

Differences in P/E averages across regions

Source: S&P Global (as of 14/09)

Studying P/E ratios across regions, we see clear discrepancies in valuations between indices. During the last decade, the S&P 500 has traded at an average P/E of 25.6x, compared to 20.2x for the OMXS30 and 20.0x for the DAX. This can be partially explained by the fact that the S&P 500 is dominated by large-cap technology firms with stable earnings and strong growth prospects, which pushes the average P/E value upwards. As of September 2025, the Magnificent 7 companies constitute ~34% of the total S&P 500 market capitalization, which illustrates how heavily weighted the American index is toward technology companies. In contrast, the Swedish and German indices are heavily weighted toward industrial, automotive, and financial companies. Companies in these industries tend to trade at more modest multiples than technology companies, due to less attractive industry characteristics, such as lower growth and higher working capital requirements

P/E by sector

Source: S&P Global (as of 14/09)

Comparing valuations across subindices over time can also be useful, as it highlights how investors’ preferences for different sectors vary over time. This is a useful comparison for investors, as it highlights the cyclical aspects of valuation. P/E fluctuations can be matched to economic cycles and analyzed to answer questions like, “How does the financial sector perform in recessions?” or “How do technology companies trade during times of high interest rates?”

As for current differences in valuations, the S&P 500 IT sector subindex trades at more than double the earnings multiple of the S&P Financials sector subindex. This can be explained by significantly higher future growth expectations for the IT sector: Consensus estimates point to 18.7% EPS growth in 2025, as compared to 6.8% EPS growth for the Financials sector subindex. Companies in the industrials sector subindex, which have long traded at around 30x earnings, are expected to grow EPS by a relatively modest 7.8% in 2025, but by 17.2% in 2026

S&P 500's P/E fluctuations over time

Source: S&P Global (as of 14/09)

While analyzing valuation ratios over time, it is important to note the ratios’ tendency to revert to their long-term mean values - a phenomenon known as ‘mean reversion’. This is illustrated in the chart above, which shows the S&P 500’s P/E value over the last 10 years, as well as the 10-year average P/E value of 25.6x. Over the last 10 years, the index has traded at extremes in both directions - reaching P/E levels as high as 45 times and as low as 16 times earnings. While financial markets can go through long periods of positive and negative sentiments, which affects the trading multiples for all stocks, valuations tend to eventually revert to the mean. While market sentiment certainly plays a role in this, underlying fundamental values, such as revenue growth and profitability figures, have also demonstrated mean reverting properties. Ultimately, P/E ratios are fundamentally driven by earnings growth expectations, return on invested capital (ROIC), and cost of equity. This means that temporary surges in optimism or fear can distort valuations in the short term, but over time they tend to align with company fundamentals.

The long-term average serves as a useful benchmark against which current trading multiples can be compared. By doing so, investors can determine whether a stock or an index is cheap or expensive in relation to its historical trading multiples.

As with most concepts in the stock market mean reversion should not be viewed in isolation. Structural changes in market dynamics can permanently alter the long-term mean valuation levels around which multiples gravitate. IPOs, de-listings, and other changes to index compositions can have large effects on valuation levels. For example, the increase in high-growth technology companies in the S&P 500 has pushed P/E levels up. Further, capital structure plays a role as well: companies with large cash positions often show high P/E multiples, since cash contributes to market capitalization, but has no direct effect on current earnings. Similarly, companies with a lot of debt will rightfully trade at lower multiples, because of the depressing effect that debt has on equity values. Because of this, mean reversion alone should be seen more as a ‘guidepost’ than a strict rule.

In conclusion, the P/E ratio is one of the most useful, simple, and widely used tools to evaluate stock valuations.  It offers insights into investor expectations and relative pricing. While it is a useful metric on its own, it truly shines when used together with other multiples and valuation methods that we will cover in later articles.