Q: Why do investors commonly use price-to-earnings ratio (P-E) to evaluate stocks, despite its shortcomings? Can you explain using Visa (V) as an example?

A: Some investors spend much of their time trying to figure out if a stock is cheap or expensive.

Unfortunately, some just look at a stock’s share price to determine if it’s a good deal. This approach, however, falls short, as you can read here .

Rather, investors need to consider a stock’s valuation, which is a way of saying what you’re getting when you buy a stock.

With consumer products, people already understand valuation. Say you see two cars for sale for $15,000. One is a beat-up Yugo with 150,000 miles. The other is a late-model Ford with 20,000 miles. Most people would understand that while both cars cost $15,000, you’re getting much more with the Ford.

Investors need to do the same kind of thing when buying stocks. There are many ways to compare price to value, but one of the most popular is the price-to-earnings ratio or P-E.

The P-E ratio tells you how much in profit one share of a company’s stock is generating. Earnings, or the profit generated by a company, is the real benefit you get by owning stock. Profit is the source of stock price increases and dividends, the primary types of returns investors enjoy.

When you buy a stock, you want to get as much of a claim to earnings as you can for every dollar you’re investing. And the P-E is a good way to see that.

Luckily the P-E is easy for investors to obtain for nearly all stocks, at the Money section of USATODAY.com and other websites. You can see here that Visa has a P-E of around 28. And its top rival, MasterCard  (MA). has a P-E of around 24 .

Clearly investors are paying a bit more for a claim to Visa’s earnings than for MasterCard’s. This is an indication that Visa has a higher valuation than MasterCard. And it is helpful information that the P-E can provide.

But to answer your question, you’re correct. You can’t assume one stock will be a better investment than another just because it has a lower P-E ratio. For one thing, if a company is growing faster than a rival, it may justify the higher valuation.

Analysts currently expect Visa’s earnings to grow 30% this fiscal year and 20% next fiscal year, according to Thomson Financial. Visa is also expected to grow 20% a year the next five years. At the same time, analysts expect MasterCard’s earnings to grow a slightly slower 20% this fiscal year and 20% in 2010, while the company’s earnings are expected to grow 18% a year the next five years, slightly slower than Visa’s forecasted growth.

There are other factors to consider, such as market share, company leadership and business risks. So you are correct; just looking at a stock’s P-E isn’t enough to determine if you should buy it. But it’s a good starting point that’s easy to understand and easy to find online.

Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies and Fundamental Analysis for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Click here to see previous Ask Matt columns. Follow Matt on Twitter at: twitter.com/mattkrantz