The humble price/earning ratio is suddenly making headlines. The Wall Street Journal reported Monday that the measure has fallen below its long-run average for the U.S. stock market. Before concluding that shares are cheap, however, investors should consider some ways the P/E can mislead.

The P/E ratio is a simple answer to an important question: How many years will it take this business to earn back my investment? A pizza parlor that costs $500,000 and earns $50,000 a year after expenses has a P/E of 10. So does a stock that sells for $15 and has yearly earnings of $1.50 a share. Since 1871, U.S. shares have sold for an average of 15 times earnings for the trailing year, according to data compiled by Yale economist Robert Shiller.

The S&P 500 is trading at 12.7 times this year's forecast for its underlying operating earnings. Forecasts, of course, aren't as reliable as already published earnings for the trailing year. The index is trading at 14.4 times earnings for the year ended June 2010--seemingly a good deal.

A buyer of the aforementioned pizza parlor might want to know two things about its earnings, however. First, do they truly factor in all expenses? Suppose the shop is in a rough neighborhood and vandals do $5,000 of damage in a typical year. A prudent buyer would include that money in the analysis. Operating earnings for the S&P 500 ignore many such unusual charges, like write-offs for corporate investments that have gone sour. The table below shows the relationship since 1988 between operating earnings and the regulatory earnings companies are required to report. (The broken line in late 2008 reflects a quarter when both measures turned negative.) Notice that operating earnings at times far exceed regulatory earnings, making companies appear more profitable than they are, but that the two measures also tend to converge.

Source: Standard & Poor's

Using reported earnings, the S&P 500 trades at 15.7 times trailing earnings, suggesting it's fully valued, and maybe even a whisker expensive.

The second question our pizza shop buyer might ask is whether the past year's earnings are typical. Maybe the shop usually earns $35,000 a year, but earned $50,000 last year only because film crews shooting nearby ordered dozens of pies every day for six months.

It's easy to assume from the national mood that U.S. corporate profits are slumping, but in fact, they were 5.3% of gross national income over the past year, versus an average of 4.9% since World War II. If anything, profits are booming. Discount trailing earnings for the S&P to adjust for the unusual plumpness of current earnings, and the index's P/E inches up to 17, suggesting investors should be cautious.

There are bargains to be found, fortunately. The three S&P 500 members below have P/E ratios below 12 based on the old-fashioned definition: the past year of profits as companies are required to report them. More important, they provide cash income of at least 3% through quarterly dividends.

Kraft

Trailing P/E (including "extraordinary" items): 11
Dividend yield: 3.9%

U.S. food giant Kraft bought British chocolate maker Cadbury earlier this year for $19 billion. Management initially said it would save $675 million by eliminating redundant expenses, but earlier this month announced the integration was going better than expected and that $750 million seems a more likely figure. Sales for Kraft, ignoring those added by the acquisition, are expected to increase only 3% to 4% this year, and profits are forecast to barely budge, but analysts expect next year's profits to increase by 13%.

Intel

Trailing P/E: 11
Dividend yield: 3.4%

Intel announced Monday it would buy the wireless business of Germany's Infineon Technologies, for $1.4 billion. The purchase highlights Intel's interest in parlaying its dominance in computer processors into a larger role in making innards for cell phones. The purchased division specializes in cellular modems and has a long customer list that includes Research in Motion, Nokia and Apple. Analysts say Intel will likely use this inroad to try to sell more of its Atom chips, which power applications for portable and handheld electronics.

Bristol-Myers Squibb

Trailing P/E: 5
Dividend yield: 4.9%

Like most of its Big Pharma peers, Bristol-Myers Squibb is expected to suffer sales declines in coming years as patents for lucrative drugs expire. Analysts say its portfolio of new drugs in development is more promising than most, however, so the declines aren't expected to be severe. Jefferies International, an investment bank, reckons 2014 sales for the company will total $17.6 billion, down from $18.8 billion last year. The stock might provide a handsome return despite slipping sales, considering its modest price and the company's $3.7 billion in net cash and equivalents, or 8% of its stock market value, waiting to be put to spent on dividends, share repurchases and promising drugs.