P/E Ratio

The price-to-earnings ratio divides the share price by earnings per share. It shows how many years of current profit the price represents. A P/E of 10 means it would take ten years of today's earnings to equal the price.

A low P/E usually reads as cheap and a high one as expensive, but low numbers often have reasons. Declining industries or falling profit expectations get marked down in advance, which is why a cheap-looking stock can be a value trap.

A high P/E is not automatically expensive either. Fast-growing companies earn little today but are priced for much more tomorrow, which is why growth stocks routinely trade at dozens of times earnings.

P/E only means something within an industry. Comparing a bank to a software company tells you little. Comparing a company against its own P/E history is often the more useful read.