The price-earnings ratio is computed by dividing the current market price per share of common stock by earnings per share.

The price-earnings ratio is computed by dividing the current market price per share of common stock by earnings per share.

a) True

b) False

Answer: a) True

Earnings per share are the portions of a company’s total profit that are attributed to each outstanding share of common stock based on the number of shares currently available in the market; the price per share of common stock is the current market value assigned to a single share of stock.

The price-earnings ratio is therefore a measure of the current value of a company’s stock in relation to its earning capacity in the present period; this is expressed as:

P/E ratio = Trading price of the company’s stock/ Earnings per share

The P/E ratio gives the investor a feel of the number of dollars investors are wishing to pay for each dollar of earnings the company makes. It is a factor that determines the company’s stock price about the company’s profits. The P/E ratio tendency which means that a higher P/E ratio can be interpreted in several ways – investors are ready to pay for the company’s shares more than the company’s earnings per share, it may reflect their expectations for the company’s future growth or any other factors. However, if the P/E ratio is low this may be interpreted to mean that the company’s stock is low because it has not been looked at by serious investors or that investors have some doubts about the company and its prospects.