Example Of The Price-To-Earnings Ratio

As you begin investing you will hear the term price-to-earnings ratio (P/E Ratio) being thrown around quite a lot. Many investors consider the P/E Ratio as the quickest way to figure out if a stock price is reasonable.

To figure out a P/E Ratio you simply divide a company's stock price by the company's earnings per share. Many websites that offer stock quotes will also include the P/E ratio somewhere within the quote.

As an example if XYZ company's stock is selling for $20.00 a share and it earned $2.00 per share last year it would have a trailing P/E of 10. ($20.00 divided by $2.00)

Many investors will not buy a stock that has a P/E ratio higher than 15. It is said that Warren Buffett will only buy stock in companies that have a trailing P/E that is less than 10.

As with all investing tools you can not rely on a company's P/E ratio 100% of the time.