A:

When it comes to valuing stocks, the price-to-earnings (P/E) ratio is one of the oldest and most frequently used metrics. It is calculated by taking a company's share price and dividing this by its earnings per share. This provides a measure of the price being paid for the earnings - the higher the P/E, the more expensive the earnings. However, a company's standalone P/E doesn't give us a full picture of how expensive a stock is unless we look at it relative to the company's industry or a broad market index such as the S&P 500 and the Dow Jones Industrial Average (DJIA).

You can find an industry's P/E by analyzing industry statistics through finance websites such as Yahoo! Finance. If your company's P/E differs greatly from the industry's, you should investigate why there is a difference. If a company's P/E is twice as large as the industry's, this means investors should proceed cautiously, because no company can grow faster than the overall industry forever.

The P/E of an index - the total price of the index divided by its total earnings - is a little more difficult to come upon. Many financial websites have P/Es for individual companies, but not for indexes like the DJIA or S&P 500. To get this information, you have to go straight to the source - the index's publishers. For example, you can find the P/E for the S&P 500 on the Standard & Poor's website and for the DJIA on the Dow Jones website.

Another way to get an estimate of the P/E ratio is to look at the P/E ratio of an exchange-traded fund (ETF), which closely follows the index in question. While this measure is not as exact as the index's own measure, the information is a lot easier to find. For example, the P/E for the Wilshire 5000 can be obtained through VIPERS or the Nasdaq 100. This will work with the DJIA and the S&P 500 as well.

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Again, the P/E found on an ETF will not be exactly the same as the P/E of the index. This discrepancy is due to the fees charged on an ETF, along with the fact that ETFs are traded on the stock market. Fluctuations in the price of the ETF are affected by both the underlying index and the regular price movement of the ETF, which acts like a stock. However, the return on an ETF is often very close to the index's return.

(For further reading, see Understanding the P/E Ratio and Introduction To Exchange-Traded Funds.)

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