|
Price to earning (P/E) ratio & what it means
If
there is one number that people look at than more any other number, it is the
“Price to Earning Ratio (P/E)”. The P/E is a ratio that investors throw around
with confidence as if it told the complete story. Of course, it doesn’t tell the
whole story (if it did, we wouldn’t need all the other numbers.)
The P/E looks at the relationship between the stock price and the company’s
earnings. The P/E is the most popular stock analysis ratio, although it is not
the only one you should consider.
You calculate the P/E by taking the share price and dividing it by the company’s
EPS (Earnings Per Share that we saw above)
P/E = Stock Price / EPS
For example: A company with a share price of Rs.40 and an EPS of 8 would have a
P/E of: (40 / 8) = 5
What does P/E tell you ?
Some
investors read a high P/E as an “overpriced stock”.
However, it can also indicate the market has high hopes for this stock’s future
and has bid up the price.
Conversely, a low P/E may indicate a “vote of no confidence” by the market or it
could mean that the market has just overlooked the stock. Many investors made
their fortunes spotting these overlooked but fundamentally strong stocks before
the rest of the market discovered their true worth.
In conclusion, the P/E tells you what the market thinks of a stock. It tells you
whether the market likes or dislikes the stock.
|
