The single most common beginner question in value investing: what PE ratio is cheap? The most common beginner answer is some version of "below 15" or "below 10." That answer is wrong, and the reason it is wrong is the most important lesson in valuation.
There is no universal PE ratio that defines "cheap." A PE of 15 in one sector is a screaming bargain. A PE of 15 in another sector is fairly priced. A PE of 15 in a third sector is dangerously expensive. This post walks through three real sectors with worked examples to make the point unmistakable.
Why a single PE threshold cannot work
The PE ratio is price / earnings per share. The inverse, earnings yield (1 / PE), is the percentage return you would get if all the earnings were paid out as a dividend immediately. A PE of 10 means earnings yield of 10 percent; a PE of 20 means 5 percent; a PE of 33 means 3 percent.
The reason a single PE threshold fails: the question is not "what is the earnings yield" but rather "what does the earnings yield need to be, given the structural characteristics of this business?" Three characteristics dominate:
Characteristic 1: Growth rate. A business growing earnings 20 percent per year can justify a much higher PE than a business growing at 2 percent per year, because the future earnings will be much larger in absolute terms.
Characteristic 2: Capital intensity. A business that requires heavy capex to maintain its earnings (utilities, miners, integrated oil) generates lower free cash flow per dollar of earnings than a capital-light business (software, asset managers). The same PE means much higher implicit FCF yield for the capital-light business.
Characteristic 3: Predictability. A business with stable, predictable earnings (consumer staples, regulated utilities) justifies a higher multiple than a cyclical business with volatile earnings (commodities, autos, semiconductors), because the predictability lowers the required risk premium.
Three sectors, three different "cheap PE" answers.
Sector 1: Software (capital-light, high growth, decent predictability)
Example: Adobe (ADBE). Adobe runs creative software (Photoshop, Premiere, After Effects) and document software (Acrobat) on subscription pricing. Capital intensity is low (software development costs but minimal physical capex). Growth is strong (10-15 percent revenue CAGR over the last decade). Predictability is decent because the subscription model produces recurring revenue with high retention.
Adobe's PE in May 2026: roughly 36. By the "PE below 15 is cheap" beginner rule, Adobe is expensive.
But:
- Adobe's FCF margin is 35 percent (every dollar of revenue produces 35 cents of free cash flow). The same PE implies a much higher FCF yield than for capital-intensive businesses.
- Adobe is growing earnings at roughly 14 percent per year. The PEG (PE divided by growth rate) is 36 / 14 = 2.6, which is above Lynch's 1.5 threshold, but the business quality is exceptional.