The Price to Earnings Ratio (P/E ratio) compares a company's current price to its per-share earnings. The P/E ratio is calculated by dividing the price per share by the earnings per share. This metric is one of the best ways to gauge the value of the stock.
If you were planning to purchase a new television, you would probably compare the features and price of multiple televisions. You would expect to pay more for more features. If one TV had fewer features and older technology but cost the same or more than other comparable TVs, that TV may not be a good value.
When a stock has a higher P/E ratio than other similar companies, investors may regard the stock as overvalued, unless the company has larger growth prospects or something else that makes the high P/E worth the money. Remember that the actual price of a stock doesn't provide an indication of value. A higher-priced stock could be less valuable when the P/E is examined.
Avoiding even a few accidents can protect your investment capital over the long term. Know the right metrics to avoid big losers and devise stock market strategies that minimize losses.