If you want to know how market has valued a company stock, Price to Earnings Ratio – P/E Ratio is important . Price Earnings ratio (P/E ratio ) is the ratio of company’s current share price to its earnings per share (EPS). P/E Ratio tells us how much do you pay for one rupee of a company’s earnings .For instance
As you can see marked in yellow is the P/E of Yes Bank .So 18.8 is Price to Earnings Ratio for yes bank it means you are paying 18.8 rupees for one rupee of earnings. To Illustrate let us see the calculation first
PE ratio = market price per share / earnings per share
Purpose of Knowing P/E Ratio :
What is the point we are trying to make here ,now we know how to calculate P/E Ratio and what it is ,But where you can use this information .You do not need to even calculate its listed on most financial website including NSE & BSE . P/E ratios are used by investors analysts ,traders to discover the relative value of a company’s shares . P/E ratio offers better insight into the stock’s growth potential.
broadly speaking a high PE ratio recommend that market participants are bullish on the stock .They are expecting the company to announce higher earnings growth in forthcoming days. It also helps in determining whether a company’s stock price is overvalued or undervalued . High P/E Ratio also indicate that the stock is being overvalued. Where as low PE ratio stock confirms market participants are not too bullish on the company’s future earnings growth. Low P/E Ratio can be interpreted as undervalued . Moreover the P/E ratio shows what the market is willing to pay today for a stock based on its past or future earnings.
In case if a company made losses, earnings are negative, than PE ratio is of no value at all . A negative PE ratio has no helpful interpretation. Therefore you should not rely only on PE Ratio you can use other indicators as well .
Types of P/E Ratio :
There are two types of P/E Ratio
Forward P/E Ratio : It uses the expected earnings for upcoming 12 months. The forward PE is generally a better indicator, but is more uncertain since future earnings have to be calculated .
Trailing P/E Ratio : Trailing PE uses the previous 12 months of earnings. However any company’s past performance doesn’t signal future behavior.
Conventionally there are certain sectors like Pharma, FMCG, IT that generally have a higher PE Where as Fertilizer sector has low P/E . So the PE ratio of a company should either be compared with its peers or competitors having collateral business activity and of similar size . So whenever you are checking P/E Ratio of any stock make sure you are comparing it with same industry and sector .The P/E ratio is not as useful when comparing stocks across different industries . Historically, the Average P/E Ratio in the market has been around 20-30 . Below we have attached few companies with lowest P/E Ratios .