What is the 'P/E ratio' commonly used for?

The 'P/E ratio', or Price-to-Earnings ratio, is a key financial metric used to evaluate a company's valuation. It is calculated by dividing the market price per share by the earnings per share (EPS). This ratio helps investors understand how much they are paying for each dollar of earnings.

When assessing a company's valuation, the P/E ratio allows for a relative comparison between different companies or against industry standards. A high P/E ratio might indicate that a company's stock is overvalued or that investors are expecting high growth rates in the future. Conversely, a low P/E ratio could suggest that a company is undervalued or that it is experiencing difficulties.

Investors and analysts utilize the P/E ratio not just to look at a company's current valuation but also to gauge market expectations for future growth based on earnings. It's an essential tool in investment decisions, particularly when comparing the price of stocks in the same sector. This makes it clear why the third option is the correct choice.