General Education Development (GED) Practice Exam

If a stock has a high P/E ratio, what does this mean?

1. The stock's price is low considering the value of the company's earnings

2. The stock pays a high dividend based on its earnings per share

3. The stock's price is high considering the value of its earnings per share

4. The company's earnings per share are high

The correct answer is: The stock's price is high considering the value of its earnings per share

A high price-to-earnings (P/E) ratio indicates that the stock's price is elevated relative to its earnings per share. This suggests that investors are willing to pay more for each dollar of earnings, which may reflect their expectations for future growth or performance of the company. A high P/E ratio often implies that the market anticipates significant future earnings growth, which can be attractive to investors seeking capital appreciation. The other options do not accurately convey the meaning of a high P/E ratio. For instance, while option A suggests the stock’s price is low considering its earnings, this contradicts the definition of a high P/E ratio, which indicates a high price relative to earnings. Option B incorrectly associates a high P/E ratio with high dividends, while dividend payments are not a direct consideration of this metric. Lastly, option D talks about high earnings per share, but a high P/E ratio implies that earnings are low compared to the price, as the focus is on the valuation aspect rather than the earnings themselves. Overall, option C accurately reflects the relationship between stock price and earnings encapsulated by the P/E ratio.