PE Ratio

PE RATIO:PE RATIO MEANING:PE RATIO FORMULA

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What is PE Ratio:-

 PE Ratio is Price to Earnings Ratio or Price to Earning Multiple. It is the ratio of a company’s share price to its earnings per share (EPS). EPS is calculated as the Company’s Net Income divided by the Total Number of outstanding shares.

PE Ratio = Companies Share Price   ÷   EPS (Earning Per share)

The full form of EPS is Earning Per Share.

EPS = Company’s Net Profit  ÷  Total Number of Outstanding Shares.

PE Ratio
PE Ratio

What the PE Ratio tells us:-

 The PE ratio is the most widely used while determining the correct price valuation of Company’s stock. It helps investors to judge whether the stock is undervalued, overvalued, or fairly valued. PE Ratio is the number of times an investor is ready to pay as compared to its earnings. In simple terms, the PE Ratio is the price the investor is ready to pay to purchase Rs. 1 EPS of the company. PE Ratio is very useful in making the right investment decision.

In a broader sense, Higher PE Ratio indicates that the company’s stock is overvalued. A lower PE ratio indicates that it is fairly or undervalued. It is not thumb rule that a high PE ratio is always bad. High-performing company may have a high PE Ratio but it is not a bad idea to purchase that share because it is an exceptionally performing company. It is worth buying that company’s share even at a high PE Ratio. It is very easy to find the PE Ration of  Stock by going to any financial website like Money Control, Groww, ET Money, or Zerodha.

Types of PE Ration:-

The most widely used PE Ratios are

  1. Forward PE Ratio: Current price of a share divided by projected future EPS of the company for 1 Year (4 Quarters)
  2. Trailing PE Ratio: Current price of a share divided by Trailing EPS of the last 1 year (4 Quarters).

The trailing PE  Ratio is more accurate than the Forward PE Ratio because the Trailing PE Ratio is based on realistic past data. Whereas the Forward PE ratio is based on projected data. But both can be used for analyzing the stock valuation.

What is a good PE Ratio:-

There is no fixed rule or formula for calculating the Good or Bad PE Ratio. You can decide whether the PE Ratio of a stock is Good or Bad by comparing it with the PE Ratio of another stock in the same industry.
 
Suppose for example “TCS” has a PE Ratio is “33″. Then you have to compare its PE Ratio with another IT company. Suppose we are comparing it with the PE Ratio of “INFOSYS” which is   “28”.
 
In this case, the PE Ratio of Infosys is better as compared to TCS. Investor ready to spend Rs. 33 to purchase Rs. 1 EPS of “TCS” and ready to spend Rs. 28 to purchase Rs. 1 EPS of Infosys.
 
The “INFOSYS” PE Ratio is better. This means the share value of INFOSYS is at a better valuation than TCS.
 
In the same way, you can compare the PE Ratio of stock with that of the Industry P/E Ratio and check whether it is undervalued, Overvalued, or Fairly valued as compared to the Industry PE Ratio. Suppose the Industry PE Ratio is 31.
 
So as per the above example Infosys’s share is undervalued or fairly valued as compared to the Industry
PE ratio by Rs. -2. Whereas TCS share is somewhat Overvalued by Rs. 2.
 

PE Ratio of Nifty

Just like the investor compares the PE Ratio of a particular stock with another company’s PE Ratio or with the Industry PE ratio to find out the real valuation of the stock. We can compare the PE Ratio of Nifty with its past PE Ratio, to find out whether the Nifty is overvalued or undervalued.

We can apply it to judge the overall valuation of the market, whether it is undervalued or Overvalued. The average PE Ratio of Nifty is “20”.  A PE Ratio below 15 is called as undervalued. A PE Ratio above “25” indicates that Nifty is overvalued. When the value of the Nifty PE Ratio is between 16 to 20, the market is fairly valued.

PE Ratio of Nifty from the Last 25 Years

CONCLUSION.

1..PE Ratio is the price the investor is ready to pay to purchase Rs. 1.00  EPS of the company.  Suppose the PE ratio of the company is 20.  This means the investor is ready to pay Rs. 20 for 1.00 EPS of the company.

2. PE Ratio = Companies Share Price  ÷   EPS (Earning Per share)

3. The full form of EPS is Earning Per Share.

EPS = Company’s Net Profit  ÷  Total Number of Outstanding Shares.

4. Types of PE Ration:- 1. Forward PE Ratio   2.Trailing PE Ratio

5. Whether The PE Ratio is good or bad can be determined by comparing it with the PE Ratio of another stock of the same industry or with the Industry PE Ratio.

6. The average PE Ratio of Nifty is 20. PE Ratio below 15, the Market is undervalued and  PE ratio above 25, the Market is overvalued. Between 16 to 20, it is fairly valued.

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