P stands for PRICE and E stands for EARNINGS with P/E being a ratio in which the price of a stock is divided its earnings per share for a 12 month period.

For instance, if a company’s earnings per share over the last 12 months were $3 and it’s selling at $30, it has a P/E ratio of 10 (30 divided by 3). That’s the easy part. More difficult is figuring out how to use the P/E ratio in making investment decisions.

Six rules of thumb:

(Keep in mind that there are always exceptions to rules of thumb!)

• Think of the P/E ratio as a sort of popularity benchmark. A stock with a high P/E is one that investors have confidence in -- they feel the company’s earnings are going to grow.

• A stock with a low P/E is said to be “out of favor.” (Out of favor, however, may represent a buying opportunity.)

• P/E ratios vary -- among different companies, among different industries. There is no one size fits all here. Recently, high-tech stocks and relatively young companies have had some of the highest P/Es.

• A company that can boast rapid growth in earnings typically has a higher P/E than a company with less exciting growth. However, stocks with high P/Es are subject to sharp price drops if their earnings come in lower than anticipated by Wall Street analysts.

• Many high P/E stocks do not pay dividends and instead use their cash to expand their business.

• Many, but not all, low P/E stocks, tend to be less risky and do pay dividends.

BOTTOM LINE:

Use the P/E ratio as one way to measure a investor perception about a stock’s future growth, relative to other stocks and to the market in general.

To help you do this, check “Value Line Investment Survey,” a weekly publication that evaluates over 1,700 stocks. It not only gives a stock’s current P/E ratio but also its “relative P/E ratio” -- the current P/E divided by the median P/E for all stocks covered by “Value Line”. (Most brokerage firms and larger public libraries subscribe, or go to: www.valueline.com.)