*I hope JavaBeans explanation helped; if not, I will try my version below:*

First of all P/E ratio that you see in most of the finance sites are the Trailing P/E. There are Current and Forward P/E but that's not important here, so let's talk about the most common P/E: Trailing P/E

First the ratio that you already are familiar with:

**P/E = (Current stock price) / (Earnings per share from the last four quarters combined).**

* Note: I haven't seen JavaBean's version (market cap/annual earnings) but I am sure it is used as fundamentally, the ratio is almost similar.*

So what is the ratio stating?

*Let me give you a real life example although P/E is strictly used in stock markets and the example below is only for demonstration purpose:*

__Real life Example:__

Say, you want to invest in a gas station which is worth 300K and the station earns 5000 a month (i.e. 15,000 a quarter and 60,000 in last four quarters).

Then hypothetically, P/E for your gas station would be 300,000/60,000 = 5.

What is it saying?

Think about it; it's saying in 5 years of time you will be able to recoup the investment you put in. So, a smaller P/E would be good right? Lesser time to recoup? Yes, in this situation.

But now, assume that you want to sell your gas station. You look at your P/E and while smaller P/E was good for you originally, it won't look so good now because you wanted more worth for your gas station. Say you wanted to sell it for $600,000. Now your P/E becomes = 600,000/ 60,000 = 10. So, a higher P/E is actually better for you now. If you were to price your station for 1.2M, your P/E would be work 20.

Now hold your horses!! An investor who is looking at your gas station and wants to buy it so he can later sell it, would like a reasonable P/E.

**Low P/E **could mean that the denominator is high (i.e. gas station is earning a lot more) OR it could mean the numerator is low (gas station is worth really low). Why is it worth low? Are other people not interested in it? They don't have confidence in the gas station??

How about a **high P/E**? Now denominator is low (i.e. gas station isn't earning much) or it's numerator is high (it is worth more). It could again be a good thing or a bad thing as, it could have been priced artificially too high OR investors have enough confidence in the station even though it is not earning much.

**What I just proved is a P/E ratio in itself doesn't say much. A low P/E ratio could be a good thing or a bad thing, same applies to high P/E ratio. **

**So what do you use this for then?**

**You combine P/E with other market indicators. **
**You typically compare P/E of a company to another company within the same industry. **P/Es for companies from different industries do not mean much.

Typically you will see P/E value of 15 for many companies. P/E around this value typically mean the valuation might have matured (an established brand), especially if the P/E has stayed steady for last few years. If P/E is too low, that means worth of the P/E is too low and could hint that investors don't have much confidence in the company since they expect lesser return in the future. If P/E is too high, it could mean the valuation of the company has been over inflated and it could crash.

Hope this helps.