The metric is calculated by dividing the stock price by earnings per share, or equivalently, by dividing market capitalization by net profit. A value of 8 means that the investment will pay back in eight years if the current profit level is maintained.
There are two calculation methods: based on the latest financial statements and based on forecasted earnings for the future period. The second option is more informative but relies on assumptions that may not materialize.
Interpretation is not simply "the lower, the better." A low value can result from undervaluation or expectations of declining profit—the market factors in the future, while the denominator reflects the past. A high value may indicate either overvaluation or expectations of rapid growth.
The metric is inapplicable when there are losses—the ratio becomes meaningless. It is also distorted by one-time items in profit and is not comparable across industries: acceptable levels for a bank, retail chain, and manufacturing company differ fundamentally. Comparison is valid only within one sector and with consistent accounting standards.