Price Earnings Ratio

P/E Ratio. It sounds good and makes novice investors feel like they have a grasp of the situation but how valuable is the Earnings Price Ratio?

Surprisingly, the price to earnings ratio is a useful tool but certainly not the holy grail of investing as it is sometimes made out to be.

For those novice investors, the P/E Ratio provides a numeric representation of the value between the stock price and earnings. To derive the P/E Ratio you divide the share price by the company's EPS or Earnings Per Share. The formula looks like this:

P/E = Stock Price/ EPS

1. Market sentiment. An overly optimistic P/E Ratio can indicate the market expects big things from this company. Temper optimism with reality.
2. Cover priced or over-bought. A high P/E Ratio can indicate a given stock is priced to high and ready for a correction. Be sure to compare against industry norms.
3. Lack of confidence. A low P/E Ratio may indicate a lack of confidence in the future of the company.
4. Sleeper. A low P/E Ratio might be a sleeper just waited to be discovered.