What Is the P/E Ratio?
The price-to-earnings (P/E) ratio is calculated by dividing a company's share price by its earnings per share (EPS). A P/E of 15x means you are paying 15 times the company's annual earnings for each share. A P/E of 30x means you are paying 30 times earnings.
In general, lower P/E ratios suggest a stock is cheaper relative to its earnings; higher P/E ratios suggest it is more expensive. This logic works reasonably well for stable, predictable businesses — banks, consumer staples, healthcare companies — whose earnings grow slowly and steadily.
Why the P/E Ratio Completely Fails for Cyclicals
Cyclical companies — shipping, energy, mining, chemicals — experience enormous swings in earnings tied to commodity prices and freight rates. At cycle troughs, earnings collapse (sometimes to zero or negative). At cycle peaks, earnings surge to extraordinary levels. This variability makes the P/E ratio not just unhelpful but actively misleading:
- At the trough: Earnings are near zero → P/E is very high or infinite → stock appears expensive → this is actually the best time to buy
- At the peak: Earnings are at record highs → P/E is very low (3–5x) → stock appears cheap → this is actually the worst time to buy
Investors who screen for "cheap" stocks using P/E ratios will consistently buy cyclicals at their peaks (when earnings are highest and P/E is lowest) and avoid them at troughs (when earnings are lowest and P/E is highest). This is the opposite of what generates good returns.
The Trough Earnings Trap
Consider Golden Ocean (GOGL) in 2016. BDI had hit its all-time low. GOGL was barely breaking even. P/E was effectively infinite. Every value screen excluded it as too expensive. Yet the stock was at $3.20 — the single best entry point in a decade, preceding a 730% return.
By 2021, GOGL had P/E of around 4–6x on peak earnings. Every P/E screen flagged it as extremely cheap. Investors who bought at this point on the basis of a low P/E then experienced the subsequent rate collapse and earnings normalisation.
What to Use Instead: P/B Ratio
For cyclical stocks, the price-to-book (P/B) ratio is far more reliable. Unlike earnings, book value (net assets) does not swing violently with commodity cycles. A shipping company's vessels are worth roughly what they were built for whether freight rates are high or low. This makes P/B a much more stable valuation anchor for cyclicals.
When a shipping stock trades at 0.6x book value, you are buying the fleet for less than its replacement cost — a margin of safety that exists regardless of current earnings. When it trades at 2x book value, you are paying a premium that can only be justified by sustained high rates — which history shows always reverts.
The Normalised Earnings Approach
For investors who prefer earnings-based metrics, the solution is to use normalised or mid-cycle earnings rather than current earnings. This means estimating what the company would earn in a normal rate/price environment (not at the trough or peak) and applying the P/E multiple to that normalised figure.
This approach — used by sophisticated cycle investors — tells you whether the stock is cheap relative to normalised profitability, rather than relative to the distorted current earnings figure.
Get cycle signals before they peak.
Signycle monitors fundamentals and technicals across all major Oslo Børs cyclical sectors — and alerts you when the data says it is time to act.