Price-to-Earnings Ratio

The price-to-earnings ratio, or P/E, is determined by dividing the closing price by the most recently available earnings per share (EPS), based upon primary EPS for the past four quarters. The P/E ratio is one of the most commonly used measures to analyze the price of a stock. It cannot be used alone to make investment decisions, you must contrast it with the company’s past P/E ratios and with the P/E ratios of similar companies to assess value. The P/E ratio generally indicates how fast the market expects the company’s earnings to grow. The higher the P/E ratio, the greater the potential growth in earnings is likely to be.

Many investors use the P/E ratio of the Dow Jones Industrial Average (DJIA) as a standard of comparison. For example, if the DJIA has a P/E ratio of 10 and an individual stock has a P/E ratio of 7, earnings are considered to be underpriced when compared to the market.