Price to Earning Ratio - P.E. Ratio

Price to Earning Ratio - P.E. Ratio

Price to Earnings Ratio - P.E. Ratio Definition

Price to earnings ratio is the first among valuation method of stocks for investment. The high stock price is a reflection of fundamentally strong business along with the behavior of market participants. Every company which has a very sound balance sheet and strong fundamentals can not assure you the best-buying bet and vice versa.

There are various aspects of studies through which we can reach the conclusion about the investment in any stock. Studies can be divided into two parts :

• Fundamental Analysis
• Technical Analysis

Ratios are the part of fundamental analysis of any company before getting into it. This theory of financial ratios was made popular by Benjamin Graham known as the father of fundamental analysis.

P.E. ratio compares the current market price of the stock with its earning per share. 

for understanding P.E. Ratio first, we have to understand the EPS (Earning Per Share). EPS confirms the companies profitability. If any XYZ company with 1000 shares generates a profit of 100,000 then EPS is 100 of that company.

Higher EPS is a good sign for the investor.

Further, if we divide the current market price with EPS then we will get PE Ratio.

We will try to simplify its meaning from the below example:

PE.Ratio = Market Price/EPS

EPS= PAT(Profit before tax)/No. of shares 

A higher EPS means that the company is profitable enough to pay more to its shareholders, it indicates more value in the company.

XYZ company market price is Rs 1000 and its EPS is Rs 100, from the above formula you will get P.E Ratio 10 so it implies that any investor is ready to pay 10 times for every unit of profit that the company earns.PE Ratio measures the willingness of the market participants to pay for the stock, if  P.E. is 10 then participants are willing to pay 10 times for every unit of profit. Higher the P.E.more expensive the stock.

The P.E Ratio you can easily get from many websites. The best website is MONEY CONTROL.

when you visit money control application you have to select the stock and then click on the valuation part and you will find as below:

Individual stock P.E. is readily available on the money control website but how to find the INDEX P.E. Ratio, please find below :

Click on the link  Index P.E and insert the date and click on P/E and check the latest figures.

SIGNIFICANCE OF  P.E. RATIO

Price to Earnings Ratio in isolation doesn't have any significance and you cannot decide that stock is overvalued or undervalued. You have to interpret P.E. levels with other ratios, and historical P.E. along with many more factors to reach any particular conclusion about a company. Lower P.E. Ratio doesn't assure you to jump on the stock and buy it because maybe any wrong happening or news could bring its level down and more P.E. doesn't mean that the stock is overvalued. In the above picture, you can see the current P.E. Ratio of HDFC AMC is 42 which is very high if we compare it with its industry P.E, so compile this information with other factors before making any rational decision about the stock

• Compare current P.E. with its Historical P.E of 3 to 5 years, if you find average P.E. of all the years much below at its historical average, then it can prove to be a good bet but make sure that business model and operating environment of the company has not changed.
• Compare the stock P.E. with its sector/Industry P.E, Stock P.E should be near or less than sector P.E, while this is not any thumb rule because in some companies stock P.E. is always more than the sector P.E. which implies that participants are ready to pay more for this company due to its quality and confidence.
• Compare the stock P.E. with a broader view that is Sensex and nifty P.E, it works well if the company is part of Sensex or nifty respectively.

TYPES OF P.E. RATIO

• Trailing P.E. Ratio: Trailing P.E. Ratio considers the EPS of the past four quarters
• Forward P.E. Ratio: Forward P.E. Ratio computed with the estimation of next year's EPS.

Reasons for Higher P.E Ratio :

High growth companies are always at higher valuations because participants are ready to pay a higher premium for their trust and confidence in such companies. They are ready to pay more today to confirm their own future growth with those companies. For. Eg. you will always find HDFC group companies on higher levels of P.E Ratio due to its quality and trust of the investors. The average P.E. Ratio is specified between 13 to 15.

Also, read Are you an Investor or a Trader?