Are you a seasoned investor? Well-versed in the language of the stock market or are you a novice? Successful investors need to be informed. Hot tips rarely pay off in the long run. To make wise investments in the stock market, it is important to understand a few key ratios.

One financial ratio that seasoned investors often rely upon to pinpoint companies that are doing well is called the Price/Earnings Ratio. The Price/Earnings Ratio --also called the P/E ratio -- is the current market price of a share of stock divided by the company's earnings per share for a twelve-month period.

For instance, if a share of company XYZ is selling for $100 per share and the company had earnings of $5 per share, then the company has a P/E ratio of 20—100 divided by 5.

Company ABC may have a price per share of $50 and also have earnings of $5 per share. Then this company's P/E Ratio is 10—50 divided by 5.

The importance of the P/E ratio is that it gives an indication of a stock's price measured against a stock's earning power. Companies that have a very high P/E may indicate that the price is too high. For instance America On Line has a P/E of 356. By contrast, Chase Manhattan Bank which has been showing excellent earnings in the past couple of years has a P/E of less than 20. Historically, the Dow Jones has had a P/E of -----.

Conversely if a stock's P/E is very low or much lower than its historical P/E then the ratio may indicate that the price of the stock is low and might be a good investment buy.

Nevertheless, despite its usefulness, the P/E ratio should never be relied on completely. Naturally economic and stock market conditions must also be considered in making a final decision about a stock.

In addition, the P/E ratios for small or young companies are often not dependable. Then an investor must rely upon other ratios or data.

For instance, it is possible that AOL's huge P/E indicates fabulous growth in uncharted territory rather than a stock price that is too high.