what is P/E Ratio and how it reflects company's financial health?

Answer 1

P/E simply gives a number which shows how much earnings per share is multiplied by to get the current market price. If you want to check the health of a company w ith P/E what you should do is find the reciprocal of this number that is divide 1 by P/E and you will get the surrogate for the present ROA which is the return on assets. The logic simply is earnings per share equates to net income factored to the number of shares outstanding and price the value of all assets factored again by the number of shares outstanding which simply reciprocating or inverting gives the ROA. This ROA if divided by (1-tax rate) multiplied by (1- interest rate) will give the ROI also called the Acid test ratio which directly gives the health of the company.

Answer 2

P/E ratio is simply the price of the stock divided by the earnings. So if you have a stock selling at $20.00 share, and its earnings are $.75 (cents) it is said to have a P/E of about 26.67.

It is not really a measure of "health" so much as it is a measure of "value" or whether a certain stock is expensive or cheap at that moment. Since share price alone does not tell you anything about what you are getting in return for that price, P/E is a quick way to put that into context.

Good Luck

Ed