P/E ratio is one of the most widely used financial tools but like any other financial tool P/E ratio cannot be used a single factor to assess the company’s financial performance. Following are some drawbacks of P/E ratio:
IT and technology companies like Uber that has strong growth potential take years to reach profitability and therefore has no earnings and consequently pose a negative EPS. At the time of calculating P/E ratio it comes out as negative and as most investors say the P/E doesn’t exist. Thus P/E ratio is not a good metrics in this case.
P/E ratio cannot be taken as a tool to compare company in different sector. Comparing the P/E ratio of pharma sector and IT sector will give biased results and make investor think that one company is superior to another company.
A company’s debt also plays a crucial role in determining its financial health but P/E ratio fails to take into account the debt aspect of the company.