P/E Ratio – Price-to-Earning Ratio Explained

What is P/E Ratio?

Price to earning ratio is a valuation ratio which tells us that “what market value’s the companies stock relative to its earnings”. Basically this metric is used to find out if stock is Overvalued or Undervalued.

How to calculate PE Ratio?

P/E Ratio is calculated by dividing market price per share of a company’s stock by its earnings per share (EPS).

How to use P/E ratio to assess the stock?

P/E is used to find out if stock is overvalued or undervalued.
Best way to assess a stock using P/E value is by comparing it with its peers form same sector. Also one should be cautious about if P/E is high then what is the reason and if it is low then why is it low.

So you should assess overall companies growth in the past and future opportunities for the company.

What does High PE ratio means?

A higher P/E ratio may suggest that investors have higher expectations for future earnings growth.

At the same time it can also be taken as, stock is overvalued (i.e. people are paying more than the intrinsic value).

What does low P/E ratio means?

Lower P/E ratio may indicate lower growth expectations from the stock. Or we can say that a stock is undervalued. There can be many reasons for undervaluation like:

• No foreseeable growth opportunities. [-ve sign]
• Industry comparision: A stock with a lower P/E ratio than its peers may be undervalued, but it’s crucial to understand industry norms.
• Earnings Stability and Growth: Examine the company’s historical earnings stability and growth. A low P/E ratio may be justified if the company has a track record of consistent earnings growth. Conversely, declining or erratic earnings may raise concerns.
• Future Earnings Outlook: Assess the company’s future earnings prospects. If the low P/E ratio is due to expected earnings growth, it could be a positive sign. Look for factors such as new product launches, expansion into new markets, or cost-cutting initiatives.

Why some comapnies have NO P/E ratio?

If a company has zero profits or it is loosing money then there is no EPS value and  hence no value to put into the denominator of formula.

Is it good if PE ratio is high?

PE ratio determines the market value of a company as compared to its earnings. If PE ratio is quite high then we can say that company is overvalued or its stock price is higher than it should actually be. This perception is based upon the previous data (Earning per share and Stock prices) or Future pridictions if we are calculating PE ratio based upon future EPS (prediction).
So we should not completely rely alon on P/E ratio.

Consider following factors while making your decision based upon P/E ratio:

• Future Expectations: High P/E generally means that market has high expectations form the company and if it doesn’t meet that, then there are higher chances of price fluctuation
• Comparision with industry: While comparing P/E ratio always compare it with its peers from same industry (Basically apples with apples). There is no fixed value of High/Low P/E, it varies from industry to industry.
• Market Conditions and Investor Sentiments: During bulish market investor might be willing to pay higher price as compared to EPS but in bearish market investors might be looking for low P/E. So for a long term investors low P/E ratio could be a good sign.
• Financial Health of Company: If you think P/E is high but company has great chances of success then you can take a bet on High P/E ratio.
• Risk Tolerance: High P/E stocks can be very volatile at times. If you have high tolerance to price changes then you can make your decision accordingly.

Is 30 a good PE ratio?

30 P/E is considered high when we compare to historical data. It is assigned to very high growing companies.

Average P/E across various sectors in India