Price-to-Earning (P/E) Ratio

Price to Earnings (P/E)

Price-to-earnings (p/e) Ratio Is Mainly Used By Investors to help this ratio tells how much the market is willing to pay for every rupee the firm earns. Example: AI, Inc.’s price to earnings is 15x, which means for every rupee the company makes in context to EPS, the market is willing to give 15 rupees.



In recent times there is a lot of debate about its relevance because it can’t capture many aspects like a moat, management credibility, etc. However, it’s one of the widely used ratios to see the degree of the valuation or pricing. This ratio is always viewed in tandem with other similar firms or the same industry.


View:

  • Lower is better based on the comparable.

  • The price-to-earnings ratio (P/E) is the ratio of a stock's market price to its earnings. It indicates how many times earnings must be invested in a stock.

  • The trailing price-to-earnings ratio is based on previous earnings, whereas the forward price-to-earnings ratio is based on future profits projections.

  • Analysts compare a company's PE multiple to that of its competitors in the same industry. The appropriate valuation of a share can be determined in this manner.


What does it mean when a company has a negative P/E ratio?

A negative P/E ratio means that the earnings per share is a negative number. In simple words, the company is not yet to be profitable and is operating at a loss.


Where to find data:

Price: It’s the market price which is the trading price on the stock exchange.

Earnings: It’s the residual income left for the common shareholders after paying off debt holders, preference shareholders, and tax authority. Earnings are also referred to as EPS which means earnings/No of a common share.


Pros & Cons of the P/E ratio:-

There are many pros and cons of the P/E ratio, here are some of them.


Pros of the P/E ratio:-

  • The P/E ratio is widely used in the stock market and even for financial stocks

  • Price-earnings ratio is very easy to calculate and readily available datapoint for most stocks

  • It helps investors quickly estimate the value of a stock also know how much they have to pay for each dollar in return for the stock

  • It helps investors to determine the company’s growth potential before they invest

  • It helps investors to compare a stock among other stocks, industries, indices, etc. also determining whether the stock is overvalued or undervalued.

Cons of the P/E ratio:-

  • There is fair chances the ratio can be manipulated with different accounting practices.

  • It Doesn’t provide a thorough or complete analysis of a company’s stock.

  • It is subjective in nature due to volatile nature of stock it difficult to know what price earnings we can sell.

  • There is some chances P/E can mislead companies operating on leverage through inflated earnings through the sale of corporate assets. These earnings make the P/E ratio to be unrealistic.

  • Companies which are making losses cannot use P/E ratio since it can’t determine losses at early stages of business growth.

Example

A company have EPS of $20 and share price is 205 than what would be the P/E ratio?

P/E= Price Per Share/Earning Per Share

PE= 205/20

=10.25

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