Price: The company’s stock price
Earnings Per Share (EPS): It is the portion of a company's net income that would be earned per share if all profits were paid out to its shareholders.
It is an indication of the financial health of the company.
If there is a company ABC with the market price of share at Rs 100 and the earnings per share is Rs 10.
So, the P/E ratio is 100/10 = 10. This means the market is willing to pay Rs 10 for every rupee of the company’s earnings.
After learning to calculate the P/E ratio, the next step is to learn how to interpret the high, low, and negative ratios.
P/E Ratio a Relative Concept
The P/E ratio is only a relative measure. So, a ratio is higher or lower only when we compare it to another company in the same industry or to the company’s performance itself.
HIGH P/ E Ratio: A high P/E Ratio is observed for Companies that grow faster than average, such as technology companies, typically have higher P/Es. A higher P/E ratio shows that investors are optimistic about the company’s growth in the future and are willing to pay a higher share price now due to growth expectations in the future.
LOW P/E Ratio: A low P/E ratio means the share price is lower than the company's earnings.
Negative P/E ratio: If a company has negative earnings, which means that they are losing money will have a negative P/E ratio. Sometimes established companies can face negative growth due to management and control reasons.
However, one should not invest in a company that experiences consistent negative growth.
Price / Earnings Growth Ratio (PEG)
The PEG ratio measures the relationship between the price/earnings ratio and earnings growth to provide investors with a more complete story than the P/E alone.
PEG helps to compare different industries before investing.
This facilitates the comparison of different industries, and each tends to have its own historical P/E ranges. Here's a comparison of the relative valuation of an Ed Tech stock and a Manufacturing company.
These two fictional companies have very different valuations and growth rates, but the PEG ratio gives an orange-to-orange comparison of the relative valuations.
The PEG ratio of the NSE 50 would be 16 / 12 = 1.33 if the NSE 50 had a current P/E ratio of 16 times trailing earnings and if the average analyst estimate for future earnings growth in the NSE 50 is 12% over the next five years
A Word of Caution
Any P/E ratio should be considered against the backdrop of the P/E for the company's industry and Sectoral Performance projections for the next five years.
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