What Is PE Ratio? What Does It Means? How To Use It? (#39)

 

P/E Ratio is one of the main aspects which should not be left unchecked by any Investor while doing Business Analysis OR Research on any Company.

Today, we shall learn some important basics of the P/E Ratio each & every Investor should know about.... the following are to be covered in this article/blog...:

1. What Does P/E Ratio Stands For? What Is P/E Ratio?
2. How Is The P/E Ratio Calculated?
3. When To Invest In A Company Based On The P/E Ratio?
4. Which P/E Ratio Is Better To Go With? Higher Or Lower!

So, now without any further ado; lets dive right into the topics.... So here we get started....

What Is P/E Ratio? What Is It Used For?

P/E Ratio stands for Price Earning Ratio. P/E Ratio basically lets us know that how much amount of money are Investors ready to Invest in a particular Company, just to earn 1₹ of profit!

In other words, P/E Ratio shows us that; how many times of the money are the Investors ready to pay to earn ₹1 of profit.

More on that, later.... but before that.... let us talk 'bout something.... which we'll just need in the process....

& that is,

How Is The P/E Calculated?

Well,
Here's the Formula:
P/E Ratio = Current Share Price / EPS (Earning Per Share).... & here is the example to simplify this concept....

Now, EPS is what we need to Calculate first!

Here's the Formula of EPS....

EPS = PAT (Profit After Tax) / Total Number Of Outstanding Shares

Let us take an example & try calculating the P/E Ratio.... & then, later... we'll understand the meaning of the pe ratio....

So in the example....

let us say there's a Company.... & it's total worth is 20,000 rs.

& it have 10,000 shares issued into the Market.... each of rs. 20.... & let's say that, the Profit After Tax of the Company is 5000 rs.

(REMEMBER IT IS JUST AN EXAMPLE!)

Now, with this we have the main components required....

& those are....

Current Share Price = 20

PAT = 5000

Number Of Out Standing Shares = 10,000

I'll let you know where can you find such info regarding the Company....

So, now.... Calculating in Simplicity!

Let's head towards the Maths, now....

So, First off.... let us go for EPS (Earning Per Share)....

EPS = PAT/No. of OutStanding Shares.

Hence, EPS = 5,000/10,000

EPS = 2

Coming to the P/E Ratio....

P/E Ratio = Current Share Price/EPS

Which means, P/E Ratio = 20/2

So, P/E Ratio = 10

>"Simple Example!"

You can find this info in Google Or there are several websites which'll help you out with that....

So in Reality.... you'll never really have the need to calculate the P/E Ratio as you can literally find it everywhere....!

Anyways, so, coming to the explanation, now,

What does this 10 P/E means?

10 rs. is what the Investors are willing to pay to earn 1 rupee of profit (from Investing) in this particular Company.

So, I hope that it makes sense now....

It's just the Times MONEY one is ready to pay.... (Times "of the profit"....) & here the times money is 10 as the profit is 1....

So it's just basically calculated to just let people know, the times money they are supposed to pay Or the investors around them are ready to pay just to make 1₹ of profit.

Just remember in a easy way.... that the P/E Ratio is basically the amount you'll pay to earn 1 rs/$/....!

But now the question arises how will we know if paying 10 rs. for earning 1₹ (rupee/rs.) is a good deal.... "How will we know that?"

So well, this is what brings us here....

When To Invest In A Company Based On The P/E Ratio?

Now, there are basically 2 ways.... by which you can know whether if it's worth Investing in a certain Company's Share....

1st one is to Compare it with the P/E of the Industry's/Sector's.... the Company is in!

The Industry's Or The Sector's P/E is basically the average of every Company's P/E which is in the Sector Or The Industry!

For Example— In the I.T. Sector/Industry.... the Industry P/E will be the average of all the Company's which are in the I.T. Sector!

So, by having a look at that particular Company's Industry's P/E, one can know.... if a Company is Overvalued Or Undervalued, compared to other Company's within the same sector!

& now talking 'bout the 2nd way....

It is to compare the P/E of one Company to other Company....

Which means that if you can't decide that in which Company to Invest in, among two Companies.... then you may just compare the P/E & go for the profitable one!

—But remember one thing.... that it is not always like a low P/E is always worth Investing in ....

So let's talk 'bout this too.... well, now.... this is what brings us here.... to....:

Which P/E Is Better To Invest In? Higher Or Lower?

Now, many of you might be in a misconception that Investing in a lower P/E is what we call Value Investing.... But no, it really can't be 'cuz it just isn't that easy! Infact, P/E Ratio can just be a part of Value Investing.... but a Share just can't be bought only on the basis of the P/E Ratio! I'll explain....

Well, actually, some Companies are sometimes not at all well performing & hence.... there P/E is low! While, some Companies are just so well performing that there P/E Ratio is always high!

So, in short you just have to know that why is a Company's P/E Ratio Such!

If a P/ E Ratio of a Company is high then why is it high.... — know if it's a well performing Company or just overvalued.... then make a wise decision....

&, similarly....

If a P/E Ratio is low then why is that so?!

Know the answers & then make any decision!

Remember, P/E Ratio is just a part of Investing "Wisely", don't just make any decision JUST BASED ON THE P/E RATIO!

Anyways, So, That's It For Today....

Thanks For Reading!