## PE Ratio: An Important Tool for Investors in Stock Selection

When the stock market experiences a correction, many investors face the same dilemma—whether current stock prices are cheap or expensive, when is the best time to buy, and how long it will take to recover the principal and make a profit. The answers to these questions are actually embedded in a widely used investment indicator—the **PE ratio** (Price-to-Earnings Ratio). This metric is especially important for value investors, as it provides a standardized framework to assess whether a stock's price is reasonable.

## What Exactly Is the PE Ratio?

The PE ratio stands for Price per Earning ratio, which is the **ratio of price to earnings**. In simple terms, it answers a key question: **If you buy this stock at the current price and the company maintains its current profit level, how many years will it take to recover your initial investment?**

This indicator is widely used because it allows for a uniform comparison of valuation levels across different stocks. Whether it’s large-cap blue chips or small-cap stocks, the PE ratio offers a comparable reference value.

## How to Calculate the PE Ratio

The calculation formula for the PE ratio is straightforward: **PE = Price / EPS**

This formula involves two key variables:

**Stock Price (Price)** is the current purchase price of the stock by the investor. The lower the stock price, the lower the PE ratio at the same EPS, meaning the investor can recover their costs more quickly.

**Earnings Per Share (EPS)** is the company's net profit over the year divided by the total number of shares outstanding. This metric reflects the profit generated per share. If investors can select companies with high EPS, even if the stock price is relatively high, the PE ratio may remain low because of a larger denominator, shortening the investment recovery cycle.

For example, if an investor buys a stock at 10 THB, with an EPS of 1 THB, the PE ratio is 10. This means the company earns 1 THB per share annually, and it would take 10 years to recover the initial investment. If the company's performance then improves and EPS rises to 2 THB, the PE ratio automatically drops to 5, reducing the recovery time to 5 years. Conversely, if performance declines, the PE ratio will expand, and the recovery period will lengthen.

**The lower the PE ratio, the generally cheaper the stock price, the faster the investor can recover the principal, and the closer the profit realization point.**

## Forward PE vs. Historical PE

Investors encounter two different types of PE ratios in practice, each with its advantages and disadvantages.

### Forward P/E

Forward PE uses the current stock price divided by **projected future earnings**. The advantage of this approach is that it is based on expectations of the company's future prospects, helping investors see growth potential. If a company is expected to grow significantly next year, the forward PE may appear relatively low, attracting investors optimistic about its future.

However, forward PE has clear limitations. Companies may intentionally give conservative earnings forecasts to lower expectations, aiming to beat these estimates when actual results are announced. Additionally, analyst forecasts can sometimes be significantly off, leading to investment decisions based on inaccurate data.

### Trailing P/E

Trailing PE is calculated based on **actual EPS over the past 12 months**. This method is more popular because it relies on real, historical data, and is relatively simple to compute. Many investors prefer using trailing PE because they consider actual data more trustworthy than third-party forecasts.

But trailing PE also has drawbacks: past performance does not necessarily predict future results. If a company has recently undergone major changes or faces new challenges, the trailing PE may not reflect these developments. Therefore, investors should not rely solely on trailing PE for their decisions.

## Limitations of the PE Ratio

Although the PE ratio is a useful tool, it is not万能 (all-powerful).

First, **EPS is variable**. The PE ratio calculated at the time of purchase based on a certain EPS can change significantly during the holding period. For example, if an investor buys a stock at 10 THB with an EPS of 1 THB, the PE is 10. But if the company later expands into new markets or launches new product lines, EPS might grow to 2 THB, causing the PE to drop to 5, shortening the recovery period from 10 to 5 years.

Conversely, if the company faces trade barriers or legal issues, EPS might fall to 0.5 THB, and the PE would expand to 20, extending the recovery time to 20 years. The same stock’s PE ratio can fluctuate greatly.

Second, the PE ratio ignores many other important factors, such as the company's debt levels, cash flow quality, and industry outlook. Relying solely on PE for investment decisions is like diagnosing a disease only by temperature—an incomplete picture.

## Practical Application Tips

Despite its limitations, the PE ratio remains an important weapon in an investor’s toolkit. Its value lies in providing a standardized, easy-to-understand valuation framework.

Successful investors do not rely on a single indicator. They use a combination of tools such as PE ratio, growth rate, and industry comparison. When they find a stock with a relatively low PE ratio, that’s just the first step. Investors need to further investigate: Why is the PE ratio so low? Is the market mispricing the stock, or does the company have genuine issues? Is the low PE due to temporary poor performance or a sign of long-term decline?

Through such in-depth analysis, investors can avoid the "cheap price trap" and truly identify undervalued good companies. As a quick screening tool, the PE ratio helps investors focus on those worth deeper research, ultimately building a more robust investment portfolio.