The price/earnings ratio of a firm is a multiplier applied to a firm’s earnings per share (EPS) to determine the value of the firm’s common stock. For instance, if a firm’s earnings per share is $5, and if its price/earnings ratio (or P/E ratio) is 10, then the market value of each share of common stock is ($5)(10) = $50. To quote Stanley B. Block and Geoffrey A. Hirt in their book Foundations of Financial Management:

The P/E ratio indicates expectations about the future of a company. Firms expected to provide returns greater than those for the market in general with equal or less risk often have P/E ratios higher than the market P/E ratio. In the figure below we give a dot plot of the P/E ratios for 30 fast-growing companies. Describe thedistribution of the P/E ratios.

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0 10 20 . 30 P/E Ratio * 40 50 60 70