A share price is just a number until you know what it buys. That is the job of the P/E ratio.
It is the share price divided by the earnings per share. It answers one plain question. How many dollars am I paying for each dollar of yearly profit?
A P/E of 20 means you pay twenty dollars for one dollar of annual earnings. The market usually pays a high multiple when it expects fast growth. It pays a low multiple when a business looks cheap or when trouble is brewing. The same low number can mean either, so the ratio starts the question. It does not answer it.
Now the blind spots. The P/E ratio ignores debt completely. A company can look cheap on P/E while its borrowings quietly grow behind the curtain. The ratio also breaks when earnings are tiny or negative, because dividing by almost nothing makes the math meaningless. And always check which earnings a site is using. The last twelve months and next year’s estimates can paint very different pictures.
So read it next to the debt line from next week’s post and the cash trail from the last two. A price tag tells you what the seller asks. It never tells you what the thing is worth.
Pocket rule: A price tag without the debt is not the full price.