NEW YORK (MONEY Magazine) - The most popular -- and misunderstood -- way to value a stock is to use the price-to-earnings ratio.

According to financial analysts and cocktail-party pundits alike, a high P/E tells you that a stock is "overvalued" and a low P/E means it's "cheap." The virtue of P/E is its seeming simplicity: It's just stock price divided by earnings per share.

The trouble is, like any kind of mental shortcut, the P/E ratio can be highly misleading. Someone who wants to sell you a stock can usually manage to, shall we say, massage P/E to fit his agenda.

Here are four things you should know about the number

There are two kinds of P/Es -- those based on the past four quarters of earnings and those that rely on a forecast of future earnings.

"When someone wants to make a stock sound cheap they use projected P/Es," says Pat Dorsey, director of stock analysis for Morningstar. That's because in a growing company, next year's "E" is always bigger -- unless, of course, the future doesn't work out as hoped.

So how good are those Wall Street forecasts? According to an analysis by StarMine, a firm that tracks equity analysts, 60 percent of companies report earnings below what analysts expected a year earlier. Consider Newell Rubbermaid.

At $31 a share, the stock had a P/E of 17, based on the consensus of analysts. Turned out, Newell earned 17 percent less than they expected, so investors really paid 21 times earnings.

Let's say a broker tells you that Wells Fargo is cheap relative to the rest of the stock market. Sure enough, Wells Fargo has a trailing P/E of 15 vs. about 18 for the S&P 500.

Here's the problem: Wells Fargo is a bank, and banks nearly always trade at a discount to the overall market. In fact, the average P/E ratio for the diversified banking sector is about 13 right now. That makes Wells Fargo look a lot less like a screaming deal.

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Be careful when using P/E to judge companies in cyclical businesses like autos, steel, paper or mining -- anything that peaks and falls sharply in line with economic cycles.

As such stocks soar, their P/Es sometimes shrink because their earnings are rising so fast. But those profits are usually bound to fall back just as dramatically. So it may be better to buy cyclicals when P/Es look high.