Understanding the Idea of Price-to-Earnings Ratio
Many people look at the price-to-earnings ratio, also called the P/E ratio, to judge if a stock or the whole market is cheap or expensive.
For a long time, there was a common belief that a P/E between 12–15 means undervalued, 15–20 means fairly valued, and anything above 20 means high risk or overvalued. This simple rule was used for many years as a basic guide.
Why Old P/E Rules No Longer Work Well
If we look at the past ten years of market data, we see something very different. The P/E of major indices rarely fell below 20.
It was close to 15–16 only a couple of times, and once during the COVID crash. Other than that, the market stayed high and kept moving even higher. Based on the old rule, the market should have been too expensive most of the time. But the market still kept rising strongly, which shows that the old limits no longer make sense.
How Global Liquidity Changed Valuations
The world has seen a huge increase in money supply. Governments and central banks printed large amounts of money and added strong monetary support. This pushed asset prices higher everywhere. Because of this, the upper limit of what is considered a “fair” P/E also increased. What used to be overvalued at 20 slowly became acceptable at 25. Many people now feel that anything below 25 is still fine. In the future, the new normal could even be 30 or 35.
Why Absolute P/E Levels Can Mislead Investors
Many investors still use P/E ratios in an absolute way, thinking that a stock is expensive just because it has a P/E of 25 or 30. But the market has changed. Some stocks even trade at P/Es of 70, 80, or 100 today. This does not mean the market is wrong—it simply means the structure of valuations has shifted. Anyone who waits for “old-style” low P/E levels may never find opportunities. Some people have not invested for almost a decade because nothing looks undervalued to them anymore.
Using P/E for Relative Comparisons Instead
P/E can still be useful, but mostly for comparing one company with another. It is helpful to see why one stock trades at 40 and another at 30. But using P/E as a strict rule for buying or selling can make investing very difficult today. A better approach for many people is to follow price trends or momentum. These methods give clearer rules about when to enter, when to exit, and how much to buy, instead of guessing based on old valuation numbers.
Final Thoughts
The market has gone through a major structural change over the years. With more money in the system, higher valuations have become normal. Understanding this shift is important for anyone who wants to invest with confidence. The goal is to learn, adapt, and use tools that fit today’s market, not the market of the past.
