THE PRICE-EARNINGS RATIO

Today I would like to finish with newspapers. So, finally, we have the "P-E ratio", or price-earnings ratio, which represents a key figure in judging the value of a stock. The price-earnings ratio—also referred to as the "price-earnings multiple", or sometimes simply as the "multiple"—is the ratio of the price of a stock to the earnings per share behind the stock.

This concept is important. In simplest terms (and without taking possible complicating factors into account), "earnings per share" of a company are calculated by taking the company's net profits for the year, and dividing by the number of shares outstanding. The result is, in a very real sense, what each share earned in the business for the year — not to be confused with the dividends that the company may or may not have paid out. The board of directors of the company may decide to plow the earnings back into the business, or to pay them out to shareholders as dividends, or (more likely) a combination of both; but in any case, it is the earnings that are usually considered as the key measure of the company's success and the value of the stock.