The price-earnings ratio is computed by dividing the stock price by what figure?

• A. Dividends per share
• B. Earnings per share
• C. Net income
• D. Book value

Answer: (B)

The main concept here is that the price-earnings ratio compares a stock’s price to how much a company earns on a per-share basis. The denominator is earnings per share, not total profits or other per-share metrics. EPS represents net income allocated to each share of common stock, so dividing the stock price by EPS shows how many dollars investors are willing to pay for each dollar of earnings. This makes the P/E ratio a gauge of valuation per unit of earnings.

Dividends per share would relate to cash payouts, not earnings, so it doesn’t fit the denominator of the P/E. Net income is the total profit for the period, not per share, and book value is equity per share—both are different measures and aren’t used in the P/E calculation.