There I was, getting a haircut at my favorite salon, Waldo's Coiffures. I usually only let Victor cut my hair, but he had somehow fallen off his roof and broken his wrist, so I was being shorn by a strange-looking fellow named Moe. He was wiry and intense, and I was alarmingly unimpressed with his own haircut. But I couldn't put up with my shaggy locks any longer, and Victor's wrist remained out of commission.

"Say, fella," Moe couldn't snip without talking, it seemed.

"You know I want you to come back here and let me cut your hair again, right? Well, to earn your devotion I'm going to give you the stock tip of your life. Check out the PowerShoe Corporation -- its ticker symbol is VOOM. It was selling for $12 a share last month and is already at $70! It's flying, man, flying! Last time I checked, the P/E ratio was a mere 10!"

Well, this did seem very interesting. I asked him, "What does the company do?"

"It's brilliant -- brilliant! They make powered shoes. Kind of like a moped, but on your feet. You operate the shoes with your toes, and they take you wherever you want to go -- no walking!"

I was intrigued. I was getting kind of tired of walking back and forth to my favorite donut store. Why not have self-propelled footwear? I knew my friends would also like them. This could be the beginning of something big.

"Y'know, Moe, I think I'm going to take you up on that tip -- thanks!"

Just at that moment, the hair stylist next to us whipped off his wig, revealing a belled velvet jester cap underneath. It was Motley Fool! I knew this meant that I was being taken for a sucker, for wherever evil stock hypesters roam, there Motley Fool will be, fighting such shenanigans, one sinister villain at a time.

"Sir! Please do not buy any shares of PowerShoe! At least not just on the advice of a shameless promoter like... Mo-Mental!"

I gasped, realizing how close I had come to being financially and perhaps literally shorn. Motley Fool continued.

"You see, a good, solid company can certainly experience a big jump in its stock price. But so can a company without many prospects, about which people are, for one reason or another, very excited. These latter companies often rise as people feed on the frenzy, and then suddenly collapse as the momentum-mavens move on. You need to do a lot of research before plunking down your savings on something like this."

"And remember when the devious Mo-Mental was touting the company's low P/E ratio? Well, that was from a month ago, when the stock was trading at $12. It's at $70 now, which means that the P/E is..."

What is PowerShoe's new P/E ratio, now that the stock has zoomed skyward? Assume that when the P/E was 10, the company's earnings were $1.20 per share and that no new earnings have been reported.

1) 5.83

2) 58.3

3) 71.20

4) 84

And the answer is...

2) 58.3.

A little math was involved, but not much.

The price of the stock is $70. The past year's earnings are $1.20. (You can also calculate P/E ratios off future, expected earnings.) 70 divided by 1.20 is 58.3. That's it!

Note that the P/E, which stands for Price-to-Earnings, fluctuates along with the price. If the price goes up, as PowerShoe's did, so does the P/E. P/E ratios also shouldn't be examined in a vacuum. You should compare a company's P/E to those of other companies in the same industry. Some industries generally have low P/Es, like the automobile industry, while fast-growing industries like computer software often sport higher P/Es.

Motley Fool ended his remarks by saying, "Good Foolish investors should remember to compare a P/E ratio to a company's growth rate. If the P/E is 58, the company better be growing really fast (faster than 58% a year, specifically) in order to justify the P/E. Now, let me finish this haircut of yours before Mo-Mental does any more damage."

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