When I first started buying stocks, I had no clue what I was doing. I’d hear buzz about a company, look at its stock price, and if it seemed cheap, I’d buy it. That strategy? Let’s just say it didn’t make me rich.
Eventually, I learned that two simple tools — ROE (Return on Equity) and P/E ratio (Price-to-Earnings) — could help me cut through the noise and make more confident, informed decisions. If you’re wondering how to use ROE and PE ratio in stock investing, let me show you how I do it — in plain English, with no finance degree required.
Why Ratios Matter (Even If You’re New to Investing)
Before we get into the nitty-gritty, here’s the big idea:
Numbers tell a story. You don’t need to be a math whiz — just learn to read the signals.
Ratios like ROE and P/E give you quick snapshots of a company’s profitability and valuation. When used together, they help you decide if a stock is worth your money — or just hype.
What Is ROE and Why Do I Care?
ROE = Return on Equity
ROE tells you how efficiently a company is using shareholders’ money to generate profits.
In simpler terms: If I give this company $1, how good are they at turning that into more money?
Here’s the formula:
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ROE = Net Income / Shareholder’s Equity
The higher the ROE, the better — usually. But context matters (more on that soon).
My ROE Wake-Up Call
I once bought shares in a company with tons of revenue, thinking it was a growth machine. But it turned out they had razor-thin margins and were barely profitable. Their ROE was a sad 3%.
Then I compared that to another company in the same sector with an ROE of 18%. They were quietly delivering strong profits year after year. I missed that the first time around.
Lesson learned: Revenue is flashy, but ROE shows what the company actually earns.
What Is the PE Ratio?
PE Ratio = Price-to-Earnings
The PE ratio tells you how much you’re paying for $1 of the company’s earnings.
Here’s the formula:
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PE Ratio = Stock Price / Earnings Per Share (EPS)
It’s a quick way to see if a stock might be overvalued or undervalued.
A high PE could mean the stock is expensive — or just that investors expect big growth.
A low PE might signal a bargain — or it could mean the market sees problems ahead.
PE Ratios in Real Life
I used to think cheap meant good. So when I saw a stock with a PE of 5, I got excited. “This is a steal!” I thought.
But it turned out the company’s earnings were declining, and investors were fleeing for a reason. That low PE wasn’t a bargain — it was a warning sign.
Then I looked at a solid tech company with a PE around 20 — not super cheap, but not overpriced either. They were growing steadily and had a history of beating earnings expectations.
Moral of the story: PE needs context — and that’s where pairing it with ROE comes in.
How to Use ROE and PE Ratio in Stock Investing (My Personal Strategy)
Let me walk you through the simple checklist I follow when evaluating a stock using these two ratios.
Step 1: Look for a Healthy ROE (15% or Higher)
A consistently high ROE is usually a green flag. It shows the company knows how to turn equity into profit.
My rule of thumb:
- ROE above 15% = Great
- ROE between 10-15% = Good
- ROE below 10% = Needs more digging
- Bonus tip: Compare ROE to others in the same industry. A grocery chain and a software company will have very different norms.
Step 2: Check the PE Ratio in Context
Once I’ve found a company with strong ROE, I ask:
- Is the PE too high compared to similar companies?
- Is it too low and possibly undervalued?
- Is the PE justified by the company’s growth rate?
- Sometimes a higher PE is okay — especially if the company is growing fast. I just don’t want to overpay without a good reason.
Step 3: Look for the Sweet Spot
My ideal combo:
- ROE above 15%
- PE under 25 (or below the industry average)
- Consistent earnings growth
- When I find this trio, I get excited. It doesn’t guarantee success, but it stacks the odds in my favor.
Example: Comparing Two Tech Stocks
Let’s say I’m comparing two tech companies.
Metric TechCo A TechCo B
ROE 19% 8%
PE Ratio 22 12
Earnings Growth Steady Declining
At first glance, TechCo B looks “cheaper.” But once I factor in ROE and earnings growth, TechCo A is clearly the smarter choice for me.
Common Mistakes I Learned to Avoid
Chasing Low PEs Without Checking ROE
Cheap stocks aren’t always good stocks. A low PE with a weak ROE can signal a company in decline.
Ignoring Industry Differences
Some sectors naturally have higher or lower PEs and ROEs. Always compare apples to apples.
Trusting One Number Alone
PE and ROE are helpful tools — but they’re not the whole picture. I also check:
- Debt levels
- Revenue growth
- Cash flow
- Management quality
- Think of PE and ROE as the first filter, not the final decision.
Tools I Use to Check ROE and PE
You don’t need fancy software. Here are my go-to free tools:
- Yahoo Finance – Look under “Statistics” for PE and ROE
- Finviz – Great for side-by-side comparisons
- Seeking Alpha – For deeper analysis and commentary
- Company 10-Ks – Yep, I skim these too now
Final Thoughts: Simplicity Wins
- Learning how to use ROE and PE ratio in stock investing was a game-changer for me. It helped me shift from guessing to investing — and made me feel way more confident in my decisions.
- You don’t need to know everything. Just start with a couple of solid metrics and build from there. ROE tells you how well a company performs. PE tells you how much you’re paying for that performance.
- Used together? They’re a powerful pair.
- Want a cheat sheet or checklist for your own stock research? Let me know — I’d be happy to put one together based on this method!
- Let me know if you’d like this turned into a printable resource or an investor-friendly one-pager!
Next Article To Read: How I Finally Stopped Overtrading (And Doubled My Focus)