#56 Price-earnings ratio: What does the P/E ratio tell us?

The P/E ratio compares the current share price to a company's earnings. It provides information about how much the investor pays for an annual profit per share. For example, if stock price is 100 francs and the annual earnings are 5 francs per share, the P/E ratio is 20 (100 divided by 5). The share price should be in a healthy ratio to the company's earnings.

Limitations of the P/E ratio

However, looking at a single year is often not very meaningful. Accounting leeway can influence the reported profit: companies set aside provisions for future costs, depreciate machinery more quickly, or take other precautionary measures. These lead to lower profits and thus a higher P/E ratio. In reality, however, cautious accounting can be viewed positively.

The Shiller P/E ratio: cyclical smoothing

To smooth out such distortions, Nobel Prize-winning economist Robert Shiller developed the cyclically adjusted P/E ratio, also known as the Shiller P/E ratio or CAPE (Cyclically Adjusted Price Earnings Ratio). This involves dividing the current price by the inflation-adjusted average profit of the past ten years. This calculation reduces the impact of individual exceptional years or creative accounting and smooths out economic cycles. Historically, the Shiller P/E ratio has fluctuated between 5 and 45, with values below 10 only occurring in times of crisis when confidence in the economy was shaken.

Taking future expectations into account

An important aspect that is often missing from P/E ratio analysis is a look into the future. If investors expect strong earnings growth, they are willing to pay more for a stock today. A well-known example is Tesla: at the end of 2020, the P/E ratio rose to over 1000 because many market participants expected high future earnings growth. In contrast, a company like Swisscom with a P/E ratio of around 20 appears cheap at first glance, but the market expects rather moderate growth here.

P/E ratio at index level

The P/E ratio can also be applied to entire indices. For example, the P/E ratio of the SPI in November 2025 is around 19, influenced by heavyweights such as Novartis, Roche, and Nestlé, while the US technology index Nasdaq is relatively highly valued with a P/E ratio of around 30. This reflects investors' expectations of strong growth-oriented tech companies.

Significance for investors

What conclusions can be drawn from this? First, a low P/E ratio alone is not a sufficient reason to buy a stock or an ETF. Comparisons should always be made within the same industry or country. Second, it is suboptimal to invest all of your capital in a single ETF with a low P/E ratio. Excessive concentration limits geographical diversification and means you miss out on opportunities in high-growth areas. That's why at True Wealth we create portfolios from ETFs that invest in different countries, sectors, and asset classes.

Do you pay attention to the price-earnings ratio when investing? Do you think the stock markets are currently overvalued? Leave us a comment or send me an email.