The P/E ratio is one of the most widely used tools for assessing whether a share looks expensive or cheap relative to its earnings. Understanding what the P/E ratio measures — and, critically, its limitations — helps you use it as one input in your research, rather than as a standalone verdict on any stock.
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Definition
The price-to-earnings ratio (P/E ratio) is a valuation metric that compares a company's share price to its earnings per share (EPS). It is calculated by dividing the current share price by the annual EPS.
P/E ratio = Share Price ÷ Earnings Per Share (EPS). EPS is the company's net profit after tax divided by the number of shares in issue. A higher P/E means investors are paying more for each unit of earnings — typically because they expect strong future growth. A lower P/E may suggest the shares are more modestly valued, or that the market is pricing in risks or declining earnings.
A trailing P/E uses the most recently reported annual EPS (actual historical earnings). A forward P/E uses analysts' consensus estimates of future earnings. Because forecasts may be wrong, forward P/E should be used with more caution. In Nigerian equity analysis, trailing P/E is more commonly used due to limited formal analyst coverage for smaller stocks.
A high P/E (for example, above the market average) can suggest investors expect strong future earnings growth, or that the stock is fashionable regardless of fundamentals. A low P/E can suggest the stock is undervalued, or that investors expect earnings to decline. Context matters: a P/E is only meaningful when compared to the company's historical range, its sector peers, and the broader NGX average.
The P/E ratio has important limitations. It is meaningless for loss-making companies (negative EPS). It does not account for balance sheet strength (a company with high debt may have a low P/E but significant financial risk). It is affected by accounting choices that inflate or deflate reported earnings. It says nothing about cash generation — a company can report high accounting earnings but generate very little cash. Always use P/E alongside other measures.
Different sectors typically trade at structurally different P/E levels because of their growth profiles and risk characteristics. Nigerian banks, for example, have historically traded at lower P/Es than consumer goods companies. Comparing the P/E of a bank to a consumer goods company without adjusting for sector differences is not meaningful. Compare like with like — within sectors and against a company's own historical range.
There is no single "good" P/E ratio — it depends on the sector, the company's growth outlook, and prevailing market conditions. The Nigerian market average P/E changes over time. Use the P/E in context: compare it to the company's own history, its sector peers, and the overall NGX multiple at any given time.
A P/E ratio cannot technically be negative, but if a company reports a loss (negative EPS), the P/E ratio is considered not meaningful or not applicable. Loss-making companies are often valued on other metrics such as price-to-book value or EV/EBITDA.
EPS is disclosed in the company's audited annual report and in its quarterly financial statements filed with the NGX. It appears in the income statement and is usually also summarised in the financial highlights section of the annual report.
Not necessarily. A low P/E can reflect genuine undervaluation, but it can also reflect the market pricing in deteriorating earnings, structural challenges in the sector, governance concerns, or illiquidity. Always investigate why the P/E is low before concluding that a stock is cheap.
The P/E ratio compares share price to earnings. The price-to-book (P/B) ratio compares share price to the book value of equity (net assets per share from the balance sheet). P/B is commonly used for Nigerian banks, where book value (particularly tangible net assets) is a meaningful measure. P/E is more commonly used for non-financial companies.
Important disclaimer
This page is for general information and educational purposes only. It does not constitute financial advice, investment advice, legal advice, or tax advice. Any figures or ratios mentioned are for illustrative purposes only and do not represent the current metrics of any specific company. The value of investments can fall as well as rise. Seek independent regulated financial advice before making any investment decision. Shares Saver does not provide financial advice.
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