Home > Articles > Business & Management > Finance & Investing

  • Print
  • + Share This
This chapter is from the book

Crunching the Numbers

Earlier in this chapter, reference was made to a rule of thumb that a stock that trades at a PE ratio less than 8 is cheap. While there are numerous benchmarks such as these in the market, you should be wary of these numbers. Many of them are outdated and have no basis in fact. In this section, you will begin by looking at the distribution of PE ratios across the market to get a sense of what would constitute a high, low or average PE ratio. You will then follow up by looking at how PE ratios vary across different sectors and also how they have changed over time. Finally, you will construct a portfolio of stocks with the lowest PE ratios in the market, with the intention of examining it more closely for potential flaws in the strategy.

PE Ratios Across the Market

While there are numerous rules of thumb when it comes to PE ratios, it is impossible to assess whether they make sense without looking at how PE ratios vary across stocks in the market. Figure 3.4 presents the distribution of PE ratios for all U.S. stocks in October 2002. The current PE, trailing PE and forward PE ratios are all presented in this figure.

03fig04.gifFigure 3.4. PE Ratios Across the Market: October 2002

Looking at this distribution, you can see that while there are a large number of companies with PE ratios between 8 and 20, there are also a significant number of companies with PE ratios well in excess of 100. Some of these companies are high growth companies that trade at high prices relative to current earnings because investors expect their earnings to grow substantially in the future. Some of these companies are cyclical companies whose earnings have dropped as a consequence of a recession. Since investors expect their earnings to bounce back as the economy recovers, the price-earnings ratio is high. At the other extreme are companies whose PE ratios are 12 or less. In October 2002, these firms would be considered cheap if you looked at just the PE ratio. A final point about these PE ratios relates to companies for which the PE ratio could not be computed because earnings per share were negative. In the sample, which included 7102 companies, 3489 companies had negative earnings in the most recent financial year and current PE ratios could not be computed for them. With trailing and forward earnings, you continue to lose about 40% of the overall sample for the same reason.

The fact that PE ratios cannot be less than zero but can take on very high values has consequences when you compute statistics. The average PE ratio, which is computed by averaging across all companies, will be pushed up by the extreme high values. A far more meaningful statistic would be the median PE; half of all companies will have PE ratios less than this value, and half of all companies will have PE ratios that are higher than this value. Table 3.1 summarizes statistics on both measures of the price-earnings ratio, starting with the mean and the standard deviation and including the median, 10th and 90th percentile values.

Table 3.1. Summary Statistics: PE Ratios for U.S. Stocks





















90th percentile




10th percentile




Looking at all three measures of the PE ratio, you see that the average is consistently higher than the median, reflecting the fact that PE ratios can be very high numbers but cannot be less than zero. It is not surprising that analysts wishing to sell you stocks often use the pitch that the PE ratio for the stock is below the average for the industry. An effective retort would be to ask them whether the PE ratio for the stock is less than the median for the industry.

PE Ratios Across Sectors

Price-earnings ratio can vary widely across sectors, and what comprises a low PE ratio in one sector can be a high PE ratio in another. In Table 3.2, the ten sectors with the lowest and the highest average PE ratios (current) in the United States in October 2002 are listed.

Table 3.2. Highest and Lowest PE Ratio Sectors









Steel (Integrated)






Telecom. Services


Electric Utility


Precision Instrument


Auto Parts








Insurance (Life)






Cable TV


Home Appliance


Wireless Networking




Chemical (Basic)


What are the reasons for the vast divergences in PE ratios across sectors? The fundamentals that were outlined earlier as the determinants of PE—growth, risk and payout (return on equity)—provide the explanation. In general, the sectors with the lowest PE ratios offer not only the lowest expected growth but also have low returns on equity. The sectors with the highest PE ratios offer higher expected growth and higher returns on equity, albeit with more risk. Table 3.3 contrasts measures of growth, risk and return on equity for the two groups: the ten sectors with the highest PE ratios and the ten with the lowest.

In estimating return on capital and return on equity, the averages over the last five years were used to overcome the depressed earnings (and returns on equity) caused by the recession in 2002. Note that the lowest PE sectors have lower projected growth in earnings and revenues and lower project returns than those in the highest PE sectors.

Table 3.3. Comparisons on Fundamentals: High PE vs. Low PE Sectors
















Low PE sectors









High PE sectors









PE Ratio Across Time

A PE ratio of 12 can be considered low in today's market but it would have been high in the equity market of 1981. As PE ratios change over time, the criteria for what constitutes a low or a high PE will also change. Consequently, the average PE ratio for all stocks in the United States is examined in Figure 3.5.

03fig05.gifFigure 3.5. PE Ratio for S&P: 1960–2001

Note that the PE ratios have varied significantly over time, reaching a low of about 7 in 1975 and climbing to a high of 33 at the market peak in 1999.

What causes PE ratios to change over time? The very same factors that determine the PE ratios of individual companies—cash flows, growth and cost of equity—also determine the PE ratios for individual companies. PE ratios were low in the mid-1970s because economic growth was dragged down by the oil embargo and subsequent inflation in the United States and because nominal interest rates were high. In fact, the period between 1975 and 1981 when PE ratios remained low represents a period when government bond rates in the United States reach double digits for the first time in history. The decline in interest rates in the 1990s accompanied by rapid economic growth and higher productivity in the 1990s contributed to making PE ratios in that decade much higher.

As PE ratios change over time, the determination of what constitutes a low PE will also change. In Figure 3.6, you examine the PE ratios that would have represented the 5th, 10th and 25th percentile of all stocks listed on the New York Stock Exchange every year from 1951 to 2001.

03fig06.gifFigure 3.6. PE Ratio: Cutoffs over Time

In 1975, the low point for PE ratios for U.S. stocks, 5% of all stocks had PE ratios less than 2.18, 10% of all stocks had PE ratios less than 2.64, and 25% of all stocks had PE ratios less than 3.56. In contrast, in 1998, 5% of stocks had PE ratios less than 9.42, 10% had PE ratios less than 11.64, and 25% had PE ratios less than 14.88. This is why a rule of thumb (e.g., PE less than 8 is cheap!) has to be taken with a grain of salt. While it would have been factual in 1998, it would not have been so in 1975, since more than half of all stocks traded at PE ratios lower than 8 in that year.

A Low PE Portfolio

If you decided to adopt a strategy of buying low PE stocks, what would your portfolio look like? The only way to answer this question is to create such a portfolio. Assume you begin with the all listed U.S. stocks and screen for the stocks with the lowest PE ratios. You have three measures of the PE ratio for each company: the PE based upon earnings in the most recent financial year (current PE), the PE based upon earnings in the most recent four quarters (trailing PE), and the PE based upon expected earnings in the next financial year (forward PE). Each measure has its adherents, and there is information in each. Erring on the side of conservatism, you can look for stocks that have PE ratios less than 10 on all three measures. The resulting portfolio in October 2002 is presented in Table 3.4.

Taking a closer look at the portfolio, you will see that 116 stocks in the market (out of an overall sample of 7000+ companies) met the criteria of having current, trailing and forward price earnings ratios all less than 10. The portfolio is fairly diversified, though utility and financial service stocks are disproportionately represented.

  • + Share This
  • 🔖 Save To Your Account

InformIT Promotional Mailings & Special Offers

I would like to receive exclusive offers and hear about products from InformIT and its family of brands. I can unsubscribe at any time.


Pearson Education, Inc., 221 River Street, Hoboken, New Jersey 07030, (Pearson) presents this site to provide information about products and services that can be purchased through this site.

This privacy notice provides an overview of our commitment to privacy and describes how we collect, protect, use and share personal information collected through this site. Please note that other Pearson websites and online products and services have their own separate privacy policies.

Collection and Use of Information

To conduct business and deliver products and services, Pearson collects and uses personal information in several ways in connection with this site, including:

Questions and Inquiries

For inquiries and questions, we collect the inquiry or question, together with name, contact details (email address, phone number and mailing address) and any other additional information voluntarily submitted to us through a Contact Us form or an email. We use this information to address the inquiry and respond to the question.

Online Store

For orders and purchases placed through our online store on this site, we collect order details, name, institution name and address (if applicable), email address, phone number, shipping and billing addresses, credit/debit card information, shipping options and any instructions. We use this information to complete transactions, fulfill orders, communicate with individuals placing orders or visiting the online store, and for related purposes.


Pearson may offer opportunities to provide feedback or participate in surveys, including surveys evaluating Pearson products, services or sites. Participation is voluntary. Pearson collects information requested in the survey questions and uses the information to evaluate, support, maintain and improve products, services or sites, develop new products and services, conduct educational research and for other purposes specified in the survey.

Contests and Drawings

Occasionally, we may sponsor a contest or drawing. Participation is optional. Pearson collects name, contact information and other information specified on the entry form for the contest or drawing to conduct the contest or drawing. Pearson may collect additional personal information from the winners of a contest or drawing in order to award the prize and for tax reporting purposes, as required by law.


If you have elected to receive email newsletters or promotional mailings and special offers but want to unsubscribe, simply email information@informit.com.

Service Announcements

On rare occasions it is necessary to send out a strictly service related announcement. For instance, if our service is temporarily suspended for maintenance we might send users an email. Generally, users may not opt-out of these communications, though they can deactivate their account information. However, these communications are not promotional in nature.

Customer Service

We communicate with users on a regular basis to provide requested services and in regard to issues relating to their account we reply via email or phone in accordance with the users' wishes when a user submits their information through our Contact Us form.

Other Collection and Use of Information

Application and System Logs

Pearson automatically collects log data to help ensure the delivery, availability and security of this site. Log data may include technical information about how a user or visitor connected to this site, such as browser type, type of computer/device, operating system, internet service provider and IP address. We use this information for support purposes and to monitor the health of the site, identify problems, improve service, detect unauthorized access and fraudulent activity, prevent and respond to security incidents and appropriately scale computing resources.

Web Analytics

Pearson may use third party web trend analytical services, including Google Analytics, to collect visitor information, such as IP addresses, browser types, referring pages, pages visited and time spent on a particular site. While these analytical services collect and report information on an anonymous basis, they may use cookies to gather web trend information. The information gathered may enable Pearson (but not the third party web trend services) to link information with application and system log data. Pearson uses this information for system administration and to identify problems, improve service, detect unauthorized access and fraudulent activity, prevent and respond to security incidents, appropriately scale computing resources and otherwise support and deliver this site and its services.

Cookies and Related Technologies

This site uses cookies and similar technologies to personalize content, measure traffic patterns, control security, track use and access of information on this site, and provide interest-based messages and advertising. Users can manage and block the use of cookies through their browser. Disabling or blocking certain cookies may limit the functionality of this site.

Do Not Track

This site currently does not respond to Do Not Track signals.


Pearson uses appropriate physical, administrative and technical security measures to protect personal information from unauthorized access, use and disclosure.


This site is not directed to children under the age of 13.


Pearson may send or direct marketing communications to users, provided that

  • Pearson will not use personal information collected or processed as a K-12 school service provider for the purpose of directed or targeted advertising.
  • Such marketing is consistent with applicable law and Pearson's legal obligations.
  • Pearson will not knowingly direct or send marketing communications to an individual who has expressed a preference not to receive marketing.
  • Where required by applicable law, express or implied consent to marketing exists and has not been withdrawn.

Pearson may provide personal information to a third party service provider on a restricted basis to provide marketing solely on behalf of Pearson or an affiliate or customer for whom Pearson is a service provider. Marketing preferences may be changed at any time.

Correcting/Updating Personal Information

If a user's personally identifiable information changes (such as your postal address or email address), we provide a way to correct or update that user's personal data provided to us. This can be done on the Account page. If a user no longer desires our service and desires to delete his or her account, please contact us at customer-service@informit.com and we will process the deletion of a user's account.


Users can always make an informed choice as to whether they should proceed with certain services offered by InformIT. If you choose to remove yourself from our mailing list(s) simply visit the following page and uncheck any communication you no longer want to receive: www.informit.com/u.aspx.

Sale of Personal Information

Pearson does not rent or sell personal information in exchange for any payment of money.

While Pearson does not sell personal information, as defined in Nevada law, Nevada residents may email a request for no sale of their personal information to NevadaDesignatedRequest@pearson.com.

Supplemental Privacy Statement for California Residents

California residents should read our Supplemental privacy statement for California residents in conjunction with this Privacy Notice. The Supplemental privacy statement for California residents explains Pearson's commitment to comply with California law and applies to personal information of California residents collected in connection with this site and the Services.

Sharing and Disclosure

Pearson may disclose personal information, as follows:

  • As required by law.
  • With the consent of the individual (or their parent, if the individual is a minor)
  • In response to a subpoena, court order or legal process, to the extent permitted or required by law
  • To protect the security and safety of individuals, data, assets and systems, consistent with applicable law
  • In connection the sale, joint venture or other transfer of some or all of its company or assets, subject to the provisions of this Privacy Notice
  • To investigate or address actual or suspected fraud or other illegal activities
  • To exercise its legal rights, including enforcement of the Terms of Use for this site or another contract
  • To affiliated Pearson companies and other companies and organizations who perform work for Pearson and are obligated to protect the privacy of personal information consistent with this Privacy Notice
  • To a school, organization, company or government agency, where Pearson collects or processes the personal information in a school setting or on behalf of such organization, company or government agency.


This web site contains links to other sites. Please be aware that we are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of each and every web site that collects Personal Information. This privacy statement applies solely to information collected by this web site.

Requests and Contact

Please contact us about this Privacy Notice or if you have any requests or questions relating to the privacy of your personal information.

Changes to this Privacy Notice

We may revise this Privacy Notice through an updated posting. We will identify the effective date of the revision in the posting. Often, updates are made to provide greater clarity or to comply with changes in regulatory requirements. If the updates involve material changes to the collection, protection, use or disclosure of Personal Information, Pearson will provide notice of the change through a conspicuous notice on this site or other appropriate way. Continued use of the site after the effective date of a posted revision evidences acceptance. Please contact us if you have questions or concerns about the Privacy Notice or any objection to any revisions.

Last Update: November 17, 2020