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Investing: P/E Ratio basic question
The idea here is to get an idea of how to value each business and thus normalize how highly prized is each dollar that a company makes.  While some companies may make millions and others make billions, how does one put these in proper context?  One way is to consider a dollar in earnings for the company.  How does a dollar in earnings for Google compare to a dollar for Coca-cola for example?  Some companies may be valued much higher than others and this is a way to see that as share price alone can be rather misleading since some companies can have millions of shares outstanding and split the shares to keep the share price in a certain range. Thus the idea isn't that an investor is paying for a dollar of earnings but rather how is that perceived as some companies may not have earnings and yet still be traded as start-ups and other companies may be running at a loss and thus the P/E isn't even meaningful in this case. Assuming everything but the P/E is the same, the lower P/E would represent a greater value in a sense, yes.  However, earnings growth rate can account for higher P/Es for some companies as if a company is expected to grow at 40% for a few years it may have a higher P/E than a company growing earnings at 5% for example.