There are many companies issuing countless stocks in the stock exchange market. It is very difficult for an individual to evaluate these stocks. There are many evaluation procedures one of them is price to earnings ratio. These ratios tell the whole story to the investor about the performance of the specific stock.



It is simple financial ratio used to calculate the earning form stock after comparing them with their prices.
Formula = Price of stock over earnings per share
This ratio simply indicates you that how much you are paying for the profits from stocks. If your price to earnings ratio is five then it means you are paying 5 times more than you are earning from the stocks in a single year. This ration can only calculate the results I a single year. In simple your all other things remain the same if the ratio is five then you can get back your investment after five years. However, there are very less chances than the companies pay such high amount of dividends. It is not very simple as it externally looks. It required understanding of the market and stocks to execute this ration in practical market.
Uses:
This used in different purpose. The main use is an evaluation of a company. We can easily evaluate a company by just price to earnings ratio of that company. If the price to earning ration of a company is eight then it is preferred upon the company which ratio is twelve.
It is very simple in evaluation. You just have to calculate the ratios and then check their standers. If the ratio is in between eight to twelve then it considered as normal. If it is below eight then it considered that the stock is undervalued. It considered good but if you go the other end then in the end it could be the constant decline in the profits of the company. There must difficulties in this ratio otherwise; it indicated the dangerous situation of the market.
When the price to earnings ratio is above twelve then it is always a danger sign for the company. I mean than a company is in a bad position and you have to pay lots more for fewer profits. This is very dangerous satiation for the investors as well as the company. An experience investor does not invest in such company. On the other hand, it can also be an indication that the ratio will move back to its normal range and the profit will be normal after some time.
For making investment in the stock exchange, you must learn and practice this ratio. This ratio helps a lot in evaluation of stocks and making investment decision. You should learn all the tools before entering into the stock market. If you jump into the market unprepared then you can do nothing and will soon feed up. On the other side if you enter into the market after proper understanding than you can easily gain success.