P/E ratio or price earnings ratio of a stock refers to the market multiplier.
P/E ratio is calculated by dividing the current market price of a stock by the previous year's earnings per share.
Generally, a low P/E would mean that a stock is selling at a relatively low price compared to its earnings.
A high P/E would indicate that a stock's price is high and may not be much of a bargain.
The P/E of one successful company may be very different from that of another successful company if the two companies are in different industries.
High-tech companies with big growth and high earnings generally sell at much higher P/Es than low-tech or mature companies where growth has stabilized.
Some stocks can sell at very high prices even when the companies have no earnings. The high prices reflect the market's expectation for high earnings in the future.
Future P/E is the Key
A knowledgeable investor recognizes that the current P/E is not as important as the future P/E.
The investor wants to invest in a company that has a strong financial future, that is, invest into its earnings potential..
In order for the P/E ratio to be helpful to the investor, much more information about the company may be needed.
Generally, the investor will compare a company's ratios for the current year with that of previous years to measure the growth of the company.
The investor will also compare the company's ratios with those of other companies in the same industry.
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