How to read PE ratio?

1) Price-Earning ratio = share price / earnings per share (EPS)

2) Simple Definition: For one year of earnings, how many times is the market valuing it?

3) Generally higher ratio means investors are confident about the future prospects of the company and vice versa. 

4) Another way to look at it is higher ratio means likely to be overvalued and lower value signals undervaluation.

5) Be wary of just using one year of earnings for cyclical company eg. Company who earns $1 every year for 9 years but at the end of the cycle earns $5.  PE ratio for a $10 company is 10 for every year and for the final year it is just 2.  SOLUTION: Take average EPS over the cycle period.

6) Historical PE = market price/trailing 12 months EPS (Good for gauging industry PE ratio)

7) Forward PE = market price/estimated future EPS (Good for forward estimation provided you can estimate the forward EPS reasonably well)

8) Be extremely wary about EPS because this is subjected to accounting treatment i.e. clever accountants can play with the numbers legally (creative accounting within the rules of accounting standards)

9) If you have only 10s to decide on a stock just take most recent market price / most recent EPS, if the ratio is high, ask yourself it is justified to be trading at such a high valuation? (Depends on your valuation of course)

10) Lastly, PE ratio is just ONE measure of value and should be used in conjunction with other ratios and valuation methods for investment decision making.