One term used in the world of stock investment that is used quite frequently is “Price-to-Earnings Ratio” or P/E ratio. As with the other terms mentioned previously, most people do not really know what a P/E ratio is. In this short essay I will attempt to explain what it is and how it applies to making wise investments.

Most people are not directly involved in day-to-day stock market activities. Their investments are tied up in their retirement funds, mutual funds, insurance programs, etc., which are handled for them by professionals. However, just about everyone has a bank account. A savings account is also a form of investing. Imagine every dollar deposited to be a share, and the interest credited to the account every quarter to be the dividend. In this case, the P/E ratio for the depositor would be around 400 — which is not very good at all. This is because a savings account at the bank offers a very low rate of interest.

To simplify this definition, consider the following: A company is in business to make money. This is called “profit.” Investors finance the company’s operations by supplying it with money — their money! This is called “capital.” Investors do this by purchasing “shares” which are simply units of capital. Just as the company expects to make a profit, the investors expect to reap a financial return on their investment, which is called a “dividend.” The so-called P/E ratio therefore is a basic indicator of the investors “va

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