PE Ratio & Equity Valuation
Overview
There are several ways to analyze a security to decide whether it’s a good investment. Most approaches fall into two broad categories:
- Fundamental analysis
- Technical analysis
This chapter focuses on fundamental analysis, which evaluates a company by examining its financial condition. This traditional approach looks closely at items like revenues, expenses, debt levels, and product and/or service lines.
Publicly traded companies must disclose financial information on a regular schedule. Analysts use these disclosures to evaluate the company, and stockholders can inspect the company’s books and records through these filings:
| Filing | What it is | Example |
|---|---|---|
| 10-K annual report | Audited financial report | Tesla 10K filing |
| 10-Q quarterly report | Unaudited financial report | Microsoft 10Q filing |
Exam trap: 10-K = annual and audited; 10-Q = quarterly and unaudited.
In these reports, fundamental analysts review financial statements to estimate a company’s value. The most commonly analyzed documents are:
| Document | What it shows | Key relationship |
|---|---|---|
| Balance sheet | Compares assets and liabilities | Assets − liabilities = net worth |
| Income (cash flow) statement | Displays income and expenses | Inflows vs outflows |
There are small differences between income statements and cash flow statements, but the exam generally does not cover them. Keep it simple and assume both provide the same information.
Where the statements themselves are covered
Reading a balance sheet and an income statement — the line items, the formulas, auditor opinions and cash vs. accrual accounting — is covered once, in Reading Balance Sheets & Income Statements.
This page covers only what the statements are used for in equity analysis.
Equity valuation from earnings
One important formula uses earnings (profits) to help evaluate the value of a company’s stock.
PE Ratio
Price to earnings (PE) ratios help investors judge whether a stock may be overvalued or undervalued.
- Price is the market price per share.
- Earnings are the company’s earnings on a per-share basis (earnings per share). Earnings come from the corporate income statement.
🔑 Formula:
PE ratio = common stock market price / earnings per share
In general, a higher PE ratio suggests the stock may be more expensive relative to its earnings.
For example, a PE ratio of 100 means the market price is 100 times the company’s annual earnings per share. Unless the company grows significantly, that price may be difficult to justify.
On average, PE ratios often fall in the 15-25 range, depending on the company and industry.
| PE level | Suggests | Typical of | Why |
|---|---|---|---|
| High PE | Investment may be overpriced | Growth companies | Expected to expand and generate larger profits in the future; stock may look “expensive” today, but investors may be willing to pay more based on expected growth |
| Low PE | Investment may be underpriced | Value companies | Often large, well-established, long track record of profits; investors may not expect dramatic growth, so they’re generally less willing to pay a high multiple of current earnings |
Growth = high PE. Value = low PE. Don’t reverse these.
Key points
Fundamental analysis
- Inspection of a company’s finances, as opposed to technical analysis of price action
Where the numbers come from
- 10-K annual report — audited
- 10-Q quarterly report — unaudited
PE ratio
- PE = market price per share ÷ earnings per share
- Earnings per share comes off the corporate income statement
- A high PE suggests the market is paying more per dollar of earnings; a low PE, less
- PE is comparative — it means little except against peers or the company’s own history
Balance sheets, income statements and their formulas are covered in Reading Balance Sheets & Income Statements.
Sources
Primary/official references for the material in this chapter. Every link was fetched and returned HTTP 200 on 2026-08-15.
| # | Source | Publisher |
|---|---|---|
| 1 | Beginners’ guide to financial statements — balance sheet, income statement | SEC |
| 2 | How to read a 10-K — the annual report sections | SEC |
| 3 | EDGAR — 10-K/10-Q/8-K filings search | SEC |
| 4 | Achievable Series 65 — chapter 1.1.10 | Achievable (course text) |