## Core Indicators of Stock Valuation: In-Depth Analysis of Price-to-Earnings Ratio

When it comes to stock investing, **the Price-to-Earnings Ratio (PE ratio) is undoubtedly the most relied-upon valuation tool** by investors. Whether professional analysts or retail investors, everyone is accustomed to using this indicator to judge whether a company's stock is worth buying. So, what information does the PE ratio actually imply? And how is it calculated?

### What exactly does the PE ratio measure?

**The PE ratio (also known as the Price-to-Earnings ratio, abbreviated as PE or PER)** essentially has a straightforward meaning—it represents how many years it would take to recover the investment cost through the company's earnings. In other words, this indicator helps you determine whether the current stock price is overvalued or undervalued relative to the company's profitability.

For example, if TSMC's PE ratio is 13, it means: at the current stock price, it would take 13 years of net profit to recover the investment. This also reflects the market's expectations for the company's future prospects—lower PE indicates relative cheapness; higher PE suggests market optimism about growth potential.

### PE Ratio Calculation Formula and Practical Application

Understanding the PE ratio calculation hinges on two key elements: **stock price** and **Earnings Per Share (EPS)**.

**Basic calculation method: PE Ratio = Stock Price ÷ EPS**

Taking TSMC as an example, suppose the current stock price is NT$520, and the EPS for 2022 is NT$39.2. Plugging into the formula gives: 520 ÷ 39.2 = 13.3. This number represents the current market valuation level.

Another method is to use the company's market capitalization divided by net income attributable to common shareholders, but the former is more common and easier to understand.

### Differences and Application Scenarios of the Three Types of PE Ratios

Investors encounter three different types of PE ratios in practice, each reflecting different time dimensions:

**Static Price-to-Earnings Ratio (Historical PE)** uses annual EPS for calculation, with the formula: Stock Price ÷ Annual EPS. Since annual data remains unchanged before the new year's report is released, PE fluctuations are entirely driven by stock price changes. For example, TSMC's 2022 EPS is NT$39.2 (Q1+Q2+Q3+Q4 = 7.82+9.14+10.83+11.41), and this lagging figure is relatively obvious.

**Rolling PE (TTM PE)** takes the sum of the most recent four quarters' EPS, better reflecting the company's current profitability. The calculation is: Stock Price ÷ Sum of the latest 4 quarters' EPS. When new quarterly reports are released, the rolling PE adjusts immediately, making it more valuable for reference than static PE.

**Forward PE (Estimated PE)** is based on analysts' forecasts of the company's EPS for the upcoming year, with the formula: Stock Price ÷ Estimated Annual EPS. While it offers a forward-looking valuation perspective, its practical use is limited due to the inherent biases in forecasts.

### How to judge whether the PE ratio is high or low?

When evaluating a PE ratio value, there are two straightforward methods.

**Peer comparison** is the first approach. PE ratios vary greatly across industries—car stocks might have a PE as high as 98, while shipping stocks might only be 1.8. Therefore, comparison within the same industry is meaningful. For example, comparing TSMC's PE with UMC, Powertech, and other peers helps determine its relative position.

**Historical comparison** is the second approach. Comparing the current PE with the company's historical PE range allows quick assessment of the current valuation level. If the current PE is below the 90th percentile of the past five years, it indicates a relatively cheap valuation, possibly presenting a good buying opportunity.

### PE Ratio River Chart: Visually Grasp Stock Price Position

In investment practice, the **PE Ratio River Chart** provides a visual tool to assess the relative position of the stock price. This chart typically includes 5 to 6 curves, each following the same formula: Stock Price = EPS × PE.

The topmost line represents the stock price corresponding to the historical highest PE, while the bottom line corresponds to the historical lowest PE. When you see TSMC's stock price located in the middle-lower region (between PE 13 and PE 14.8), you can intuitively judge that it is currently undervalued, often a good entry point.

### Limitations of the PE Ratio and Supplementary Indicators

Although the PE ratio is widely used, it is not a perfect tool.

First, **PE ignores a company's debt**. Two companies with the same PE might have vastly different risk levels—one with a healthy capital structure, another heavily leveraged. During economic adjustments, the latter faces much greater pressure.

Second, **judging high or low PE solely can be misleading**. A high PE might result from short-term poor performance but a strong company foundation, with the market still optimistic about its prospects; it could also be due to widespread growth expectations leading investors to pre-allocate; or simply because of overvaluation needing correction. Historical experience often cannot fully explain the current situation.

Third, **PE cannot evaluate unprofitable companies**. Many startups or biotech firms have yet to turn a profit, so alternative indicators like **Price-to-Book ratio (PB)** or **Price-to-Sales ratio (PS)** are needed.

PB measures the stock price relative to net asset value per share, suitable for cyclical industries; PS focuses on stock price relative to revenue per share, especially useful for high-growth but unprofitable companies. Each of these three indicators has its strengths and should be flexibly applied based on the company's characteristics.

### The Role of PE Ratio in Investment Decision-Making

Understanding the PE ratio does not guarantee investment success. Stocks with low PE may not necessarily rise in the future, and stocks with high PE may not necessarily fall. Many tech stocks maintain high PE ratios over the long term, yet their stock prices keep reaching new highs because the market is optimistic about their long-term growth potential.

Therefore, it is best to consider the PE ratio alongside other fundamental indicators, industry outlook, and company competitiveness. Mastering the calculation formula and the underlying logic of the PE ratio is just the first step in building a sound investment decision framework.