What is P/E Ratio in Share Market?

The P/E ratio is commonly known as the Price-to-earnings ratio. So it is a popular financial metric used by investors to evaluate the company stock prices: relative earnings. It is the proportion of a company's share price to earnings per share. 

This ratio shows the expectation of the market and it is the price which you must have to pay per unit of shows expectations of the market and it is the price you must pay per unit of the current earnings. 

What is the P/E Ratio Formula? 

The formula of P/ E  Ratio formula is given below:

P/ E Ratio = Market Value per share / Earning Per Share

For Example, if a company stock is trading at Rs.100, and its earnings per share is Rs.10 then its P/ E ratio would be,

P/ E = 100/ 10 = 10

So this means that the investors are willing to pay 10 times the company earnings for each share. The best basic P / E formula takes the current stock price and earnings per share to find the current P/ E. 

So Earning per share is found by taking earnings from the 12 months divided by the weighted average shares outstanding. But earnings can be normal for the unusual or one-off item which impacts the earring abnormally.

Real-World Example Of P/ E Ratio 

For a real-world example of the P/ E ratio for your more clearness:

Reliance Industries Limited

We will take the example of Reliance Industries Limited (RIL), which is one of India's largest companies.

As an example, 

Stock Price - INR 1278.20

Earning Per Share - 50.19

Using the P/ E ratio Formula:

P/ E Ratio = Market Value per share / Earning Per Share

P/ E Ratio = 1278.20 / 50.19

= 25.60 (round off)

This means the Reliance Industries stock is trading at the 25.60 time its earrings. So the investors are willing to pay 25.60 for every INR 1 of the company earnings.  

Interpretation: The P/E ratio of 25.60 indicates that reliance is relatively well-value, so investors expect steady growth in the future, to assess if this is high or low, you would compare this with the P/ E ratio of similar companies in the Indian market, such as HDFC Bank and many more.

Tata Consultancy Services

We will take the example of Tata Consultancy Services (TCS), which is one of the major IT companies in India.

As an example, 

Stock Price - INR 4427.45

Earnings per share -  131.12

Using the P/ E ratio Formula:

P/ E Ratio = Market Value per share / Earning Per Share

P/ E Ratio = 4427.45/ 131.12

= 33.80(round off)

So this means that the Tata Consultancy Services stock is trading at 33.80 times its earnings, which means the investors are willing to pay INR 33.80 for every INR 1 of Tata Consultancy Services earnings.

Interpretation: The P/E ratio of 33.80 indicates the high growth expectation for Tata Consultancy Services. As an investor believes that the company will continue to grow at a very strong pace, and comparing the P/ E ratio with other companies which is int the IT sector and the broader Indian Market will give a good understanding of Tata Consultancy Services which is overvalued or fairly priced.

Types of P/E Ratio

Here are three types of P / E ratios:

• Forward P/ E Ratio: So this estimates the company's future earnings which is based on the projection, and gives investors an idea of where the stock might be headed.
• Trailing P /E ratio: This ratio is to earn from the 12 months. So it is the most commonly used P/ E ratio since it relies on actual data.
• Shiller P/ E Ratio: This is also known as the cyclically adjusted P / E (CAPE). So this ratio smooths out the fluctuation by averaging the earnings over the past 10 years.

Also, Check: What is Face Value of Share?

Why is the  P/E ratio important?

Here the P/ E ratio is important for many reasons:

• Growth expectation is when a high P / E ratio indicates that investors expect strong future growth, while a low P/ E ratio could signal undervaluation or a company facing challenges.
• Valuation Assessment helps investors determine whether a stock is undervalued or not overvalue compare to its historical performance or industry peers.
• Comparing companies, where the P/ E ratio allows the investor to compare the companies of different industries, sizes, or regions to make informed investment decisions.

What is a Good P/E ratio Number?

Stocks in different sectors trade in different valuation (P/ E) ranges, as the stock with higher earning growth potential has a higher P /E ratio. We cannot use any single P /E level across all the stocks to infer whether the price is attractive.

So you should look at the historical P/E  of the stock and see if the current P/E is near the higher end of the range or the near lower end of the range if the stock is trading near the lower end of the range which can be a good investment opportunity to the other factors.

NIFTY has historically traded in a P/E range of 10 to 30. The average P/ E of NIFTY in the last 20 years was around 20. So, a P/E below 20 may provide a good investment opportunity. The lower the P /E below 20, the more attractive the investment potential.

Conclusion

So we have discussed the P /E ratio, its formula, types, importance, and what makes a good P/ E ratio number. The P /E ratio is an essential metric for the stock investor, helping to evaluate a company's valuation and growth potential. While the P/E ratio offers value, it should be used in conjunction with other analysis tools to make the most informed investment decision.