Whenever I go shopping, I love finding a great bargain. The same is true when it comes to the stock market, but figuring out whether or not something is on sale can sometimes be tricky.

One of the many tools investors use to identify stocks that may be undervalued are price to earnings ratios. The price to earnings ratio, or P/E ratio, is calculated by dividing the stock price of a company by its earnings per share. The concept behind P/E ratios is simple: a price to earnings ratio tells you how much you need to spend in order to acquire a dollar of a company’s earnings.

Typically, a stock with a lower P/E ratio is preferable to a stock with a higher P/E ratio. When comparing P/E ratios, it is important that the stocks you are looking at are in the same sector, since P/E ratios vary from sector to sector.

Price to earnings ratios are only one of the tools that should factor into your investment decision. Other factors you should consider include industry climate, competitive advantage, and a company’s management team—just to name a few.

The information on this page is provided for educational purposes only and is not tax, legal, financial planning or investment advice. Neither the information nor any opinion expressed in this section constitutes an offer to buy or sell any securities or advisory products. The information provided is general and is not information reasonably sufficient upon which to base an investment decision and should not be considered a recommendation to purchase or sell any particular security. You should not regard this information as a substitute for the exercise of your own judgment. Investing involves risk.