What is the PE ratio?
PE ratio: the price-to-earnings (PE) ratio is a parameter that is used to get the valuation of a company's stock price. It measures the company’s current share price corresponding to the company's earnings per share (EPS). With the PE ratio, we estimate that a stock is overvalued, undervalued, or fairly valued with respect to the company's earnings.
What is the formula for the PE ratio?
The formula to calculate PE ratio is:
PE ratio = Market price per share / earnings per share (EPS)
What is EPS?
Earnings per Share (EPS): It is like a measure of company’s profitability. Think of EPS as a way to measure how much money each share of the company’s stock earned over a period of time (quarter or year). higher EPS means a company is generating more profits, which is a good 👍 sign.
What is the formula for EPS?
The formula to calculate EPS is:
EPS = Net Income / Number of outstanding shares
Exampleof how to calculate PE ratio
Assume a company has the following details:
Market Price per Share: ₹50
Net Income: ₹1,000,000
Number of Outstanding Shares: 200,000
First, we have to calculate EPS
EPS = 1,000,000 / 200,000 = 5
Next, calculate the PE ratio PE Ratio = 50 / 5 = 10
It means that the PE ratio is 10, indicating that investors are interested in paying ₹10 for every ₹1 of earnings the company generates.
Despite these things, we have some limitations with the PE ratio.
Earnings Variation: Earnings can vary due to various reasons, which will affect the PE ratio.
High Debt: High debt can decrease net income, and the PE ratio will automatically affect that.
With these limitations, the PE ratio is still a popular and useful measure for investors to get an idea of stock valuation.
Thanks for reading.