What is Price-to-Earnings Ratio (P/E)?

A is correct. Stock A has a P/E ratio of $120 ÷ $8 = 15, while Stock B has a P/E ratio of $90 ÷ $3 = 30. A lower P/E ratio (15 vs 30) indicates investors are paying less per dollar of earnings, suggesting Stock A is more attractively valued on a relative basis. For value investors like Jennifer, lower P/E ratios typically indicate better value, assuming similar growth prospects.

B is incorrect because Stock B's P/E of 30 is higher than Stock A's P/E of 15, making it less attractively valued (investors pay more per dollar of earnings). C is incorrect because absolute earnings ($8 vs $3) don't determine valuation attractiveness; the P/E ratio standardizes the comparison by relating price to earnings. D is incorrect because the absolute stock price ($90 vs $120) doesn't indicate valuation; a $10 stock with $0.25 EPS (P/E of 40) is more expensive on a relative basis than a $200 stock with $20 EPS (P/E of 10).

B is correct. The P/E ratio is calculated as Stock Price ÷ Earnings Per Share (EPS). This ratio shows how much investors are willing to pay for each dollar of company earnings.

A describes a calculation that would yield a similar result (since market cap = price × shares and net income ÷ shares = EPS), but this is not the standard P/E formula and is less practical for individual stock analysis. C describes the price-to-book (P/B) ratio, which compares stock price to book value per share, not earnings. D describes the reciprocal of dividend yield (dividend yield = dividend ÷ price), which is a different valuation metric focusing on income rather than earnings.

C is correct. Calculate: P/E Ratio = $75 ÷ $4.50 = 16.67, which rounds to 16.7. This means investors are paying approximately $16.70 for every $1 of annual earnings.

A (12.5) incorrectly calculates using $6 as EPS instead of $4.50, perhaps confusing the numbers. B (14.8) might result from an arithmetic error or using an incorrect EPS value. D (18.0) incorrectly uses $4.00 as EPS instead of $4.50, showing the importance of precise calculation ($75 ÷ $4.00 = 18.75, close to option D).

C is correct (the EXCEPT answer). A higher P/E ratio does NOT always indicate a better investment. In fact, value investors typically seek lower P/E ratios, as they indicate paying less per dollar of earnings. High P/E ratios can signal growth expectations (positive) or overvaluation (negative), depending on context.

A is accurate: High P/E ratios (typically above 20-25) can reflect investor optimism about future growth OR indicate the stock is overpriced relative to current earnings. Context matters. B is accurate: P/E ratios are most useful when comparing companies within the same industry or sector, as different industries have different typical P/E ranges (tech companies often have higher P/Es than utilities). D is accurate: When a company has negative earnings (losses), the P/E ratio calculation produces a negative number, which is not meaningful for valuation purposes. Analysts typically use "N/A" or alternative metrics for unprofitable companies.

D is correct. Statements 1, 2, and 4 are accurate.

Statement 1 is TRUE: Stock X trailing P/E = $50 ÷ $2.50 = 20.

Statement 2 is TRUE: Stock Y forward P/E = $80 ÷ $4.00 = 20.

Statement 3 is FALSE: Stock Y has a trailing P/E of $80 ÷ $5.00 = 16, compared to Stock X's trailing P/E of 20. The lower trailing P/E (16) means Stock Y appears MORE attractively valued than Stock X on a trailing basis, not less. This statement incorrectly suggests Stock Y is less attractive.

Statement 4 is TRUE: Stock X has improving earnings expectations. Its trailing EPS is $2.50 but projected EPS is $3.00, showing 20% earnings growth. This results in a forward P/E of $50 ÷ $3.00 = 16.7, down from the trailing P/E of 20. A declining P/E ratio (when price stays constant) indicates improving earnings, which is positive.