Given a stock price of $120 and diluted EPS of $4, what is the P/E ratio and what does it suggest?

• A. P/E = 30; indicates price relative to earnings and should be compared to the industry average for context.
• B. P/E = 30; indicates earnings exceed price.
• C. P/E = 0.033; indicates very low price.
• D. P/E cannot be determined from these figures.

Answer: (A)

Understanding how to compute and interpret the price-earnings ratio shows how much investors pay for a dollar of earnings. The P/E ratio is calculated by dividing the stock price by diluted earnings per share. With a price of 120 and diluted EPS of 4, the P/E is 120 ÷ 4 = 30. A P/E of 30 means the stock is valued at 30 times its annual diluted earnings, i.e., investors are paying 30 dollars for each dollar of earnings. This number should be compared to the industry average or the company’s own historical P/E to gauge valuation—whether 30 is high, low, or fair depends on growth expectations and peers. It does not imply that earnings exceed price; rather, it reflects how richly the market prices current earnings.