More Details on the P/E ratio*

The p/e ratio of any company that's fairly priced will equal its growth rate. That is, the growth rate of the company's year-to-year earnings. For example, if the p/e of Coca-Cola is 15, you'd expect the company to be growing at about 15% a year, etc. Therefore, a company selling at a p/e ratio that is less than its growth rate MAY be a bargain - and vice versa.

Here's how to compare growth rates to earnings, while also taking the dividends into account:

Find the long-term growth rate by averaging the company's historic earnings growth for the last 5 to 10 years. Next, add the dividend yield, and divide by the p/e ratio. Here's, an example,

-Company X's growth rate is 12%
-Company X pays a 3% yield
-Company X has a p/e of 10

This would give you the following: (12 + 3) / 10 = 1.5

Evaluating the Resulting Figure:
Here's an approximate scale of how to rank the result from the previous step,
-Less than 1 is poor
-1.5 is okay
-2+ is what you should be looking for

For example, a company with a 15% growth rate, a 3% dividend, and a p/e of 6 would result in a fabulous 3.

*Peter Lynch, "One Up On Wall Street".