With an abundance of market information literally at investors’ fingertips, the price/earnings ratios of publicly traded companies are easier than ever to find but often more difficult to interpret. In fact, knowing the P/E ratio of a single company, a basket of stocks, or the overall market may not be particularly helpful unless you are in a position to make meaningful comparisons.
Put simply, the P/E ratio is calculated by dividing a stock’s current price per share by the company’s earnings per share over a 12-month period. It quantifies what investors may be willing to pay for one dollar of earnings. Thus, a P/E ratio of 10 means that investors would pay $10 for every $1 the company earns. P/E ratios may serve as a better indicator of a stock’s underlying value than the market price alone, but it’s essential for investors to understand what they represent.
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