Stock Market Technical Analysis for Excellent Investments

The Price/Earnings (P/E) ratio is simply the market price of a company's shares divided by the company's earnings per share. It is widely (and wrongly) regarded as a measure of value - supposedly a way to quickly determine if a company's shares are cheap.

Market commentators, amateur investors and even some professionals use it because it is easy to calculate. But for investment success the path of least resistance is not reliable.

Two companies, each with $10 of equity, producing a return on equity of 5%, and each trading on a P/E ratio of 10, would produce entirely different returns to the investor if there was any variation in the dividend payout ratios. For this reason the P/E ratio of 10 has told the investor nothing about which company is better value.

Put simply, Price is what you pay, but Value is what you get. Because the P/E ratio uses price it cannot estimate value.