WHAT IS THE PRICE/EARNINGS RATIO?

The price/earnings (P/E) ratio is a measure used by investors to tell whether a stock is underpriced or overpriced.

The P/E ratio relates a firm's current market price to its net earnings for the past year. The earnings of a firm are considered a good indicator of the firm's worth. A stock's current market price indicates the value that investors assign to it based on their beliefs about the company's current and future earnings. Therefore, a stock's current market price is usually greater than its current earnings per share. If a stock is trading with a P/E ratio greater than 20/1, it often means investors expect strong future growth in earnings of that corporation.

Calculating a P/E ratio is fairly simple to do. You simply take a firm's current market price and divide it by net earnings per share for the last 12 months.

P/E ratios for most stocks are listed in the business section of your local paper.

Now that you know what a P/E ratio is and how to calculate it, let's talk about the importance of the P/E ratio for investors.