In finance, the P/E ratio of a stock (also called its "earnings multiple", or simply "multiple" or "PE") is used to measure how cheap or expensive share prices are. It is probably the single most consistent red flag to excessive optimism and over-investment. It also serves, regularly, as a marker of business problems and opportunities. By relating price and earnings per share for a company, one can analyze the market's valuation of a company's shares relative to the wealth the company is actually creating. A PE ratio is calculated as:

P/E ratio=Price per Share\Earnings per Share

Earnings per share = Net income for past 12 months / Outstanding shares

The price per share (numerator) is the market price of a single share of the stock. The Earnings per share (denominator) is the Net income of the company for the most recent 12 month period, divided by number of shares outstanding.

The PE of a stock describes the price of a share relative to the earnings of the underlying asset. The lower the PE, the less you have to pay for the stock, relative to what you can expect to earn from it. The higher the PE the more over-valued the stock is.

For example, if stock A is trading at 24 and the Earnings per share for the most recent 12 month period is 3, then the PE ratio is 24/3=8. Stock A said to have a PE of 8 (or a multiple of 8). Put another way, you are paying 8 for every one Rupee of earnings.

The main reason to calculate PEs is for investors to compare the value of stocks, one stock with another. If one stock has a PE twice that of another stock, it is probably a less attractive investment. But comparisons between industries, between countries, and between time periods are dangerous. To have faith in a comparison of PE ratios, you should be comparing comparable stocks.

Normally, stocks with high earning growth are traded at higher PE values. Say, Stock A may earn 6 per share the next year. Then the future PE ratio is 24/6 = 4. i.e. you are paying 4 for every one Rupee of earnings which is more attractive.