Final answer:
The price to earnings ratio measures the "multiple" that the stock market places on a firm's earnings, indicating how much investors are willing to pay per dollar of earnings, which corresponds to option 3.
Step-by-step explanation:
Understanding the Price to Earnings (P/E) Ratio
The price to earnings ratio (P/E ratio) is a fundamental measure used to determine the value of a company's shares. It is a key indicator used by investors when making decisions about buying or selling stocks. The price to earnings ratio measures the "multiple" that the stock market places on a firm's earnings, which is option 3 from the provided list. This means it indicates how much investors are willing to pay per dollar of earnings.
To calculate the P/E ratio, you divide the market value per share by the earnings per share (EPS). For example, if a company's stock is trading at $100 per share and the EPS is $5, then the P/E ratio is 20. This implies that investors are willing to pay $20 for every $1 of earnings. The P/E ratio can provide insight into how high the market is valuing a company's future growth and profitability compared to others. However, it does not measure dividends directly, nor does it represent the percentage of dividends to net earnings.
The historical context of P/E ratios is also important. As indicated by the data presented, stock market returns can come from both dividends and capital gains. While in the past, dividends have been a significant portion of stock returns, more recent trends have seen lower dividend yields and greater reliance on capital gains for investor returns. Nevertheless, the P/E ratio remains a crucial part of stock valuation.
In summary, the correct option for what the price to earnings ratio measures is option 3: The "multiple" that the stock market places on a firm's earnings.