PE ratio also known as Price to Earning ratio and is the most popular ratio among the investors. They use this to identify undervalued or overvalued stocks. By using it investors enhance the area of margin of safety and secure their investment.
How to calculate PE ratio?
PE ratio = market value per share / EPS(earning per share)
Examples of calculation
Assume:-Market value per share = 40EPS (earning per share) = 12PE ratio = 40/12 = 3.5
- Market value per share = 40Earning per share = 5PE ratio = 40/5 = 8
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|PE ratio and Its analysis|
How to use it? Or PE ratio using tips:-
- Lower PE ratio is better than higher PE ratio for selection of stock because low PE mean high earning per share and high PE mean low earning per share. And we need high earning per share.
- Stock/share’s PE ratio compare with other same industry’s PE ratio. If both companies market cap nearly same then better to compare.
- Compare Company’s PE ratio with nifty and sensex PE ratio. First:- take the average of 10 years PE ratio of both nifty and sensex then compare it with your company.
Reasons of high PE ratio:-
- Low EPS (earning per share)
- Market value of share is too high comparing to its intrinsic value. It means, sharp decline may occur in near future because high price will not sustain for long duration.Mean:- Overvalued stock.
Reasons of low PE ratio:-
- High EPS (earning per share), it is good for investment.
- Market value of share is too low comparing to its intrinsic value. It means, upward trend may occur in near future, when market recognize share’s real value.Mean:- Undervalued stock.
Limits of PE ratio:-
- Only on the basis of low PE ratio never invest in any company, what is reason behind it always check. Use it with other ratios like debt to equity, EV/EBITDA etc.