What does a stock's P/E ratio represent?

A stock's P/E (price-to-earnings) ratio is a crucial financial metric that illustrates how much investors are prepared to pay for each dollar of a company's earnings. This ratio is calculated by dividing the current share price by the earnings per share (EPS). It effectively serves as an indicator of the company's valuation: a higher P/E ratio might suggest that investors expect future growth, while a lower P/E may indicate that the stock is undervalued or that growth is not anticipated.

This understanding is fundamental for investors as it aids in comparing companies within the same industry or sector, assessing whether a stock is overvalued or undervalued relative to earnings performance. The P/E ratio is a vital tool in investment analysis, as it encapsulates market sentiment towards a company's earnings potential.