IMPORTANCE OF THE PRICE/EARNINGS RATIO

The price/earnings ratio is one of the easiest tools you can use to measure the value of a stock. You can use it to measure whether a stock is undervalued or overvalued, which will help you decide whether to buy or sell it. P/E ratios can help you sort the "winners" from the "losers," and are so important that you can find them in the business section of your local paper.

P/E ratios are useful when comparing companies in the same industry. The company with the lower P/E ratio may be undervalued and a better stock pick. A company's P/E ratio compared to an industry average may be useful to deciding whether to buy or sell a stock.

Although P/E ratios are quoted in financial publications, most analysts adjust them to account for factors that can distort their meaning. To help you fine-tune the P/E ratios, we will discuss what some of these factors are.

Let's start by looking at the external factors that can influence the P/E ratio.