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Lesson 12. Evaluating Stocks > The Price/Earnings Ratio - Pg. 67

Evaluating Stocks 67 As a side note, I work in a bank, and I'm still not familiar with all of the mass of statistics that crosses my desk. I do, however, attempt to learn what is being determined by an equation as I am made aware of it. As an investor, make it a point to try to become increasingly familiar with the "financial stuff." While it may not be essential, it will make you a better-informed investor. The Price/Earnings Ratio The price/earnings ratio is a measurement of how much income the investor can expect from the initial investment. It is measured by dividing the price of the stock by the amount of money the stock issued (or is expected to issue) in dividends over a 12-month period: Current Market Price of Stock: $10 ÷Earnings over 12-Month Period: $1 = Price/Earnings Ratio: 10 Thus, $10 ÷ $1 = 10. Plain English The price/earnings ratio is the ratio of a stock's current price relative to its earnings over a determined period of time. The current market price of the stock is the amount for which the stock is currently trading. In the preceding example, to buy a share of that stock today would cost $10. The earnings are the total of the dividends paid by the stock over a 12-month period. Since dividends are usually paid quarterly, in the same example we know that the total of the four dividend payments was $1. (Let's say that the dividend was $.25 each quarter: .25 + .25 + .25 + .25 = $1.00.) Finally, although in theory you are free to choose any 12-month period you like, there are three 12-month periods that are used