Price-to-earnings ratio (P/E)

The price-to-earnings ratio (P/E) is the relationship between a company's earnings and its share price, and is calculated by dividing the current price per share by the earnings per share.

A stock's P/E, also known as its multiple, gives you a sense of what you are paying for a stock in relation to its earning power.

For example, a stock with a P/E of 30 is trading at a price 30 times higher than its earnings, while one with a P/E of 15 is trading at 15 times its earnings. If earnings falter, there is usually a sell-off, which drives the price down. But if the company is successful, the share price and the P/E can climb even higher.

Similarly, a low P/E can be the sign of an undervalued company whose price hasn't caught up with its earnings potential. Conversely, a low P/E can be a clue that the market considers the company a poor investment risk.

Stocks with higher P/Es are typical of companies that are expected to grow rapidly in value. They're often more volatile than stocks with lower P/Es because it can be more difficult for the company's earnings to satisfy investor expectations.

The P/E can be calculated two ways. A trailing P/E, the figure reported in newspaper stock tables, uses earnings for the last four quarters. A forward P/E generally uses earnings for the past two quarters and an analyst's projection for the coming two.