How to Use the P/E Ratio to Find Undervalued Stocks (Without Getting Tricked by the Numbers)

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When you're trying to figure out whether a stock is undervalued or overvalued, one of the first tools most investors look at is the P/E ratio. And for good reason — it’s simple, it’s widely used, and it gives you a quick way to gauge how a stock is priced compared to its earnings.

But here's the truth: relying on the P/E ratio alone can mislead you just as much as it can help you.

So in this piece, I want to break down what the P/E ratio really means, how to use it to spot value, why different sectors have wildly different “normal” ranges, and why you can’t judge every stock by this one metric — especially in a world where companies like Tesla or Nvidia can have nosebleed P/Es and still be investor darlings.

Let’s start with the basics.

What Is the P/E Ratio, Really?

P/E stands for Price-to-Earnings ratio. It tells you how much investors are willing to pay for each dollar of a company’s earnings.

The formula is simple:

P/E = Share Price / Earnings per Share (EPS)

If a stock is trading at $100 and its EPS over the past year was $5, the P/E ratio is 20. That means investors are paying $20 for every $1 of current earnings.

In theory, a low P/E means the stock is cheap, and a high P/E means it's expensive. But the reality is much more nuanced.

How to Use P/E to Spot Undervalued Stocks

A lot of value investors look for stocks with low P/E ratios — especially when those companies are financially strong and still growing.

For example, if you find a stock with a P/E of 8 in a sector where the average is 15, and the company has decent cash flow and solid fundamentals, that could be a sign it’s undervalued.

But here’s the key: you always need to compare a stock’s P/E ratio to its peers and its sector average. Looking at it in a vacuum doesn’t tell you enough.

Also, check if the low P/E is a trap. Sometimes the market gives a stock a low valuation because of real risks — declining earnings, too much debt, management issues, or just being in an outdated industry.

That’s why you don’t just look at the P/E number. You look through it.

When a High P/E Doesn’t Mean Overvalued

On the flip side, just because a stock has a high P/E doesn’t mean it’s overvalued.

Take Tesla. Its P/E has floated anywhere between 60 and 300 in recent years. That’s sky-high compared to the broader market. But investors are pricing in massive future growth — not just in electric cars, but also in AI, energy storage, and autonomous driving.

Same goes for Nvidia, which has been trading at over 50x earnings. Is it “overvalued”? Maybe. But if earnings keep growing 40–50% per year, that P/E might not be crazy after all.

The key is: the P/E is a snapshot of current price vs. past earnings. It says nothing about future growth.

If a company’s earnings are expected to explode, today’s high P/E can actually come down quickly as the “E” in the equation grows.

Growth vs. Value: Different Investing Mindsets

This is where understanding your investing style matters.

• Value investors look for low P/E stocks with solid fundamentals that are priced below their intrinsic value.

• Growth investors are willing to pay higher P/Es because they expect big gains in earnings down the line.

Both strategies can work — but mixing them up can lead to trouble. If you’re a value investor and you buy high P/E growth stocks, you might get burned when expectations fall short. If you’re a growth investor and focus only on low P/Es, you might miss out on the biggest winners.

Know your strategy. Then use the P/E to reinforce it, not replace it.

Why Different Sectors Have Different P/E Norms

This part is crucial — and often overlooked.

Not all industries trade at the same P/E ratio. Some sectors are naturally more stable, some grow faster, and others are more cyclical. That affects how investors value their earnings.

Here’s a rough idea of what’s considered a “normal” P/E by sector:

• Tech: 20–35+

• Utilities: 10–15

• Healthcare: 15–25

• Energy: 5–15

• Consumer staples: 15–20

• Financials: 10–15

So if you see a utility company trading at a P/E of 30, that might be way overpriced. But if a high-growth tech firm is trading at 30, that could be completely reasonable.

Context is everything. Always compare P/Es within sectors — not across them.

Look Beyond the Basic P/E

If you really want to be a smarter investor, take it one step further.

Here are a few metrics that complement the P/E ratio:

• PEG ratio (Price/Earnings to Growth): Adjusts the P/E for expected earnings growth. A PEG under 1 is often considered a good value.

• Forward P/E: Uses projected earnings for the next 12 months instead of past earnings. Gives you a sense of where the company is headed.

• EV/EBITDA: Focuses on enterprise value compared to earnings before interest, tax, depreciation, and amortization. More useful for comparing companies with different debt levels.

P/E is a starting point — not the whole picture.

What the P/E Ratio Can’t Tell You

This is where many investors go wrong. They look at the P/E like it’s gospel. It’s not.

The P/E ratio doesn’t tell you:

• If a company has strong cash flow

• If management is competent

• If the business has pricing power or competitive advantage

• If a recession could crush earnings next year

• If growth is slowing or accelerating

It also doesn’t tell you if earnings are inflated by one-time gains or accounting tricks. Sometimes, companies post great EPS numbers in a single quarter that make their P/E look good — but it's not sustainable.

So always dig into the company’s financials and trends. The P/E is just one signal in a much bigger system.

Use It, But Don’t Worship It

I think the P/E ratio is a great tool — especially for value investors. It’s quick, easy to use, and gives you a high-level idea of how expensive a stock is.

But I also think it's easy to misuse. A low P/E doesn’t mean a stock is safe. A high P/E doesn’t mean it’s doomed. And just because something looks “cheap” doesn’t mean the market is wrong.

You have to understand what you’re buying — the business, the growth potential, the risks.

Tesla will probably never trade at a P/E of 10. And a utility company will probably never trade at 50. That’s okay. They’re different animals. What matters is whether the price you’re paying makes sense based on what you expect from that company in the future.

If you want to get serious about stock picking — especially with a value mindset — then understanding the P/E ratio is a must. But don’t stop there.

Learn the story behind the numbers. Use the P/E alongside other tools. Compare companies within their sectors. Think about the future, not just the past. And always ask the hard questions:

Sometimes it’s wrong. And if you can figure out when it is — that’s where the real opportunity lies.

DISCLAIMER: None of this is financial advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. Please be careful and do your own research.