If you’re looking to get serious about investing in shares, one concept you’ll come across pretty quickly is the Price-to-Earnings (P/E) ratio. It’s a simple metric on the surface, but when used correctly, it can give you a powerful edge in identifying whether a stock is trading below or above its real value.
Let’s be honest — the JSE and other markets are noisy places. Share prices jump around for all sorts of reasons. But the P/E ratio cuts through some of that noise by showing how a company’s share price relates to its actual profits. In this guide, I’ll break down how to use it (and when to be cautious), and I’ll also show you how to pair it with other metrics to help you make sharper investment decisions.
What Is the P/E Ratio, Really?
In plain terms, the P/E ratio shows how much investors are willing to pay for each rand of a company’s earnings. It’s calculated like this:
P/E Ratio = Share Price ÷ Earnings Per Share (EPS)
So, if a company’s share price is R100 and its earnings per share is R10, the P/E ratio is 10. That means you’re paying R10 for every R1 of earnings the company makes.
There are two main types you’ll hear about:
- Trailing P/E – based on the last 12 months of earnings
- Forward P/E – based on estimated earnings for the next 12 months
Both can be useful, but they tell slightly different stories. Trailing looks at what’s already happened. Forward is more about what investors think will happen.
Why Investors Care About the P/E Ratio
The reason the P/E ratio gets so much attention is because it gives a quick snapshot of how the market values a company’s earnings. It doesn’t tell you everything, but it’s often a good starting point.
Here’s why it matters:
- ✅ It helps you compare companies in the same industry
- ✅ It can highlight stocks that might be cheap or expensive relative to their peers
- ✅ It tells you how much optimism (or pessimism) is priced into the share
But — and this is important — a low P/E doesn’t always mean a bargain, and a high P/E doesn’t always mean overvalued. Context is key.
Using the P/E Ratio in Real-World Investing
Let’s look at a few ways you can apply the P/E ratio when analysing stocks.
1. Compare It to the Industry Average
A company’s P/E ratio on its own isn’t very useful. You need to compare it to others in the same sector. Here’s a simple example:
| Company | Share Price (ZAR) | EPS (ZAR) | P/E Ratio |
| RetailCo | R60 | R6 | 10 |
| CompShop Ltd | R90 | R6 | 15 |
| Sector Average | – | – | 13 |
In this case, RetailCo’s P/E is below the industry average, which could mean it’s undervalued — or the market might be worried about something.
2. Look at Growth Expectations
Sometimes a company has a high P/E because investors expect big things from it. To factor in growth, use the PEG ratio (Price-to-Earnings-to-Growth):
PEG = P/E ÷ Expected Annual EPS Growth (%)
If a company has a P/E of 12 and expects 15% earnings growth, the PEG is 0.8 — which is usually a good sign. A PEG under 1 is often considered a sign of value.
3. Compare to the Company’s Own History
This is one many people forget about. Look at the company’s own historical P/E range over the past few years. If it normally trades around 18, and it’s now at 12, that might be an opportunity — especially if the business fundamentals haven’t changed much.
4. Consider the Bigger Picture
Sometimes an entire sector is under pressure (think banks during economic downturns, or tech stocks after a hype cycle). A low P/E in that context might just mean the whole sector is out of favour — not necessarily that it’s a screaming buy.
Other Metrics to Use Alongside the P/E Ratio
The P/E ratio is a great tool, but it’s not the whole picture. Here are a few others to have in your toolkit:
🔍 A Few Key Metrics to Keep in Mind
- Price-to-Book (P/B) – Useful for asset-heavy businesses like banks or insurers
- Dividend Yield – Important if you’re looking for income
- Return on Equity (ROE) – Shows how well the company turns equity into profits
- Debt-to-Equity – High debt can signal risk, especially in rising rate environments
- Free Cash Flow (FCF) – Tells you how much real cash the business generates
Using these in combination gives you a much better idea of whether the company is worth investing in.
Quick Case Study: Is This Stock Undervalued?
Let’s say you’re looking at a mid-cap retail stock listed on the JSE:
- Share Price: R55
- EPS: R7
- P/E Ratio: 7.9
- Industry Average P/E: 14
- Projected EPS Growth: 10%
PEG = 7.9 / 10 = 0.79
On paper, this stock is trading well below the industry average and has a PEG under 1. That looks promising. But before jumping in, you’d want to check: Why is the market pricing it so low? Is there a risk you’re missing? That’s where the other metrics — and your own judgement — come in.
Watch Out for These Red Flags
Low P/E stocks can be traps too. Here are a few things to watch for:
- 🚩 Declining revenue or profits
- 🚩 Mounting debt
- 🚩 Legal or regulatory issues
- 🚩 Loss of market share
- 🚩 Bad management track record
The goal is to find companies that are undervalued for no good reason, not ones that are cheap for a reason.
Frequently Asked Questions
What is a “good” P/E ratio?
It depends on the industry. A good P/E in one sector could be bad in another. Generally, anything under 15 is seen as moderate, but always compare it to sector peers and growth expectations.
Can a P/E ratio be negative?
Yes — if the company is making a loss. In that case, the P/E will show as “N/A” or negative. These are riskier investments, especially if there’s no clear path back to profitability.
Is trailing or forward P/E better?
Neither is better — they just serve different purposes. Trailing is based on actual results. Forward is based on analyst expectations. Use both for a balanced view.
Should I use the P/E ratio alone to make decisions?
No — it’s a starting point, not the final answer. Always combine it with other financial ratios, news, management quality, and industry trends.
Final Thoughts
The P/E ratio is a brilliant tool when used correctly, but it’s not magic. Think of it like a compass — it helps point you in the right direction, but you still need a map and some common sense to get to your destination.
If you’re new to investing, start by learning how to use the P/E ratio to narrow down your options. Then dig deeper. Look at the company’s growth, its sector, its track record, and where it fits into the bigger economic picture.
By being thoughtful — and not just chasing low numbers — you can use the P/E ratio to uncover genuine opportunities and avoid costly mistakes.
