## Essential Reading for Beginners: What Exactly Is PE, and Why Is It So Important?

If you start investing in stocks, you'll notice a frequently appearing term—PE, or Price-to-Earnings ratio. Whether you're an experienced investor or a professional analyst, you’ll often use it to judge whether a stock is cheap or expensive. **So what exactly is PE? Why is it so crucial?** In simple terms, PE is an indicator used to measure whether buying a stock is "worth it."

## What Is PE? One Sentence to Understand Instantly

**PE stands for Price-to-Earning Ratio, also called the Price-Earnings or P/E ratio.** It answers a straightforward question: If you buy this stock now, how many years will it take to recover your investment principal through the company's earnings?

For example, TSMC's current PE is about 13, which means:
- The company needs 13 years to earn back its current market value
- Or, you need to hold the stock for 13 years to recover your investment through profits

**This is PE telling investors in the simplest way: Is this stock expensive or cheap right now?**

## How Is PE Calculated? Two Methods

Calculating PE is quite simple; the most common way is: **Stock Price divided by Earnings Per Share (EPS).**

Another method is: Company Market Cap divided by Net Profit attributable to common shareholders, which works on the same principle.

For example, TSMC's current stock price is 520 NT dollars, and its EPS in 2022 was 39.2 NT dollars, so PE = 520 ÷ 39.2 = 13.3. This gives you a concrete PE number.

## There Are Three Types of PE—Don’t Mix Them Up

Depending on the EPS data used, PE is divided into two main categories: one based on historical data and one based on forecast data.

**First: Static PE—The Most Direct Reference**

Static PE uses last year's EPS. The formula is: **Stock Price ÷ Annual EPS**

Annual EPS is announced when the company releases its annual report, or can be calculated by summing the EPS of four quarters. For example, TSMC's 2022 EPS is 7.82 + 9.14 + 10.83 + 11.41 = 39.2.

**Why is it called "static"?** Because the annual EPS is fixed before the new annual report is released, and PE changes only with stock price fluctuations. Its characteristic is—**a lagging indicator**, unable to immediately reflect the latest profit situation.

**Second: Rolling PE—A More Real-Time Reference**

This method uses the total EPS of the most recent 12 months, as listed companies release quarterly reports, effectively summing the latest four quarters' EPS. The formula is: **Stock Price ÷ Total EPS of the last 4 quarters**

Using TSMC as an example, if the newly released Q1 2023 EPS is 5 NT dollars, then the latest four quarters' EPS are: 2022 Q2 9.14 + Q3 10.83 + Q4 11.41 + Q1 2023 5 = 36.38. PE = 520 ÷ 36.38 ≈ 14.3.

Compared to the static PE of 13.3, the rolling PE becomes 14.3. **This method is called TTM (Trailing Twelve Months). Its advantage is overcoming lagging issues, providing a quicker reflection of the latest profitability.**

**Third: Dynamic PE—Looking at Future Expectations**

Some analysts forecast the company's EPS for the next year and use that to calculate PE. For example, if an institution estimates TSMC's 2023 EPS to be 35 NT dollars, then the dynamic PE is 520 ÷ 35 ≈ 14.9.

**But there's a trap:** Different institutions' forecasts vary greatly, and they often overestimate or underestimate, making this number less reliable. **Its practical use is limited.**

## How to Tell if PE Is Reasonable? Two Methods to Help You Judge

When you see a PE number, how do you know if it's high or low? Investors usually use two approaches.

**Method 1: Compare with Peers**

PE varies greatly across industries. According to data from the Taiwan Securities Exchange in February 2023, the average PE in the automotive industry is as high as 98.3, but in shipping, it's only 1.8. **Obviously, comparing these two industries makes no sense.**

So, you should compare companies within the same industry and similar business models. For example, TSMC PE=13, UMC PE=8, and Powertech PE=47. — all are wafer manufacturers, so they can be compared. TSMC's PE is in the middle, not particularly high.

**Method 2: Compare with the Company’s Own Historical PE**

Compare the current PE with its past few years' PE to see if it's expensive or cheap now. If TSMC's current PE is 13, and over the past five years, 90% of the time PE was above 13, then the current valuation is relatively cheap.

## PE River Map: A Visual Tool to See Stock Price Highs and Lows

Is there a more intuitive way to judge whether a stock's price is reasonable? Yes, the **PE River Map**.

The principle is simple: **Stock Price = EPS × PE multiple**. By plotting lines based on the highest, lowest, and average historical PE multiples multiplied by the current EPS, you can see where the current stock price stands. The position indicates whether it's overvalued or undervalued.

For example, TSMC's latest stock price falls within the band of PE ratios from 13 to 14.8, which is on the lower side, indicating the stock is relatively undervalued—**a potential buy signal.** But remember, undervaluation doesn't guarantee a rise; many factors influence stock prices.

## Is a High or Low PE Better? There’s No Absolute Answer

Many think that a lower PE is always better, but **PE high or low has no direct correlation with stock price movement.**

A stock with a low PE doesn't necessarily rise, and a high PE doesn't necessarily fall. Investors are willing to assign high valuations to stocks they believe have good future growth prospects. That's why tech stocks often have high PE ratios and keep hitting new highs. **This reflects the market's pricing of future growth potential.**

## The Three Major Weaknesses of PE You Must Know

Although PE is very useful, it has limitations.

**Weakness 1: Ignores Debt Impact**

A company's value includes both equity and debt, but PE only considers equity profits. Two companies with the same PE, one debt-free and one highly leveraged, have very different risks. During economic downturns or rising interest rates, high-debt companies are riskier. **So, don’t rely solely on PE; also examine the company's financial structure.**

**Weakness 2: Hard to Define Absolute High or Low PE**

A high PE might mean the company is temporarily in a downturn with declining profits, but the company itself is fine, and the market still holds it. Or it could be due to high future growth expectations, with the market pricing in that potential. Or simply, the stock has overrun. **These situations are difficult to judge based solely on historical experience.**

**Weakness 3: New and Loss-Making Companies Cannot Use PE**

Many startups and biotech firms have no profits, making PE=0 or meaningless. In such cases, investors turn to other metrics like Price-to-Book (PB) or Price-to-Sales (PS).

## How to Choose Among PE, PB, and PS?

| Indicator | Chinese Name | Calculation | How to Use | Best For |
|------------|----------------|--------------|------------|----------|
| PE | Price-Earnings Ratio | Stock Price ÷ EPS or Market Cap ÷ Net Profit | Lower PE indicates cheaper stock | Stable profitable companies |
| PB | Price-Book Ratio | Stock Price ÷ Book Value per Share or Market Cap ÷ Shareholders’ Equity | PB<1 means stock is undervalued, PB>1 means overvalued | Cyclical companies |
| PS | Price-Sales Ratio | Stock Price ÷ Revenue per Share or Market Cap ÷ Revenue | Lower PS indicates cheaper stock | Unprofitable new companies |

## Summary: PE Is the Compass for Investment Decisions

**PE essentially answers a question: Is this stock's current price reasonable?** By understanding the three calculation methods—static, rolling, and dynamic PE—and using peer comparison and historical analysis, along with visual tools like the PE river map, you can better grasp a stock's valuation.

But don’t forget, PE is just one of many investment references. Factors like debt structure, industry outlook, and management quality are equally important. **Combining PE with other indicators is the smart investor’s approach.**