The Price Earnings Ratio (PER) is a measure uses in valuing both the stock market as a whole and individual stocks.

PER is calculated as the ratio of a company’s share price to its earnings per-share. The value is the same whether the calculation is done for the whole company or on a per-share basis.

PER = Price/Earnings

For example, the PER of company A with a share price of $20 and earnings per share of $2 is 10.

The higher the PER, the more the market is willing to pay for each dollar of annual earnings.

The PER does not work very well as a timing device, but it can give you some idea of the whether the market is “cheap” or “expensive”. Normally companies expected to grow and have higher earnings in the future should have a higher PER than companies in decline.

Many people use it to determine whether the market (or a given stock) is “expensive” or “cheap”. A $1 stock with a PER of 30 is much more “expensive” than a $100 stock with a PER of 10.

Many value investors made their fortunes spotting those low PER stocks before the rest of the market discovered their true worth. A fairly low PER at the time of purchase is important in ensuring ‘margin of safety’.