If you have ever watched a financial news or discussion program on television or picked up a copy of the financial section of a daily newspaper, then you know you have entered another world with its own language and terminology. To the uninitiated it often seems as if the stockbrokers, financial consultants, and market watchers are always speaking or writing in some hidden code. Even the most common terms like bonds, yields, dividends, annuities, etc., can leave a person feeling obtuse. It's almost as if the financial professionals want to keep the minions at arm's length " the "you're going to need me- attitude! Indeed, with the current widespread interest in the stock market (and the many personal losses suffered by enthusiastic amateurs), we certainly do need to have a sound understanding of the many specialized terms.
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.
The price/earning ratio is defined as the price of a share in a company's stock divided by the company's earnings per share. If, for example, a company's stock sells for $50 per share and its earnings are $5 per share, the stock's P/E ratio is 10 ($50 • $5 = 10).
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 "value-for-money.