What Is a P/E Ratio? And Why Does It Matter?

The P/E (price-to-earnings) ratio is a quick and easy way to get a feeling about how a stock or even an industry sector is currently valued by the stock market. Is it cheap? Fairly priced? Expensive?

Being simple, a P/E ratio can’t give you a final and definitive answer because there are some things (like dividends) that are excluded from the calculation. But when I see an entire stock index with an average P/E ratio that is twice what I’ve always thought of as “fair,” it makes me nervous.

To settle my nerves, I ask my experts, Sean and Dominick, what they think. Often, they remind me that the way we set up the original Legacy Portfolio was to withstand all sorts of stresses on market prices. And right now, for reasons that I explained in today’s “Main Course” essay (above), they are not suggesting that we make any changes.

If you are not familiar with P/E ratios, here’s a good introduction.