What is PE ratio and how does it help while investing in Indian stock market?
If you ever watched the proceedings of the share market live on TV or on the Internet, you must have noticed people mentioning `PE' quite frequently. What is this PE they talk about, and why is such an important factor while investing in the Indian share market? PE is short for price-earning ratio, and if you want to make any money at all in the share market in India, it's necessary for you to come to grips with it. To cut a long story short, PE is the market price per share divided by the earnings per share (EPS). You can also calculate the PE of the share market index. For instance, the PE of the Sensex for the year 2012-13 is 17.19.
So exactly how does the PE help you make investment decisions on the share market? Generally, a stock with a high PE means that the company is expected to have higher earnings growth. Stocks whose forecasted earnings are expected to be low will have a lower PE ratio.
Before we go further, we must understand what EPS is all about. EPS is simply the amount of earning per share. It is calculated as profit divided by weighted average common shares. It is another good indication of a share's potential. High EPS means that the company is making good profits and therefore a good buy.
The price-earnings ratio shows how much investors are prepared to pay for each rupee of earnings and is useful while investing in the share market. For example, a PE ratio of 10 indicates that an investor is willing to pay Rs 100 for every Rs 10 of profits (earnings) that a company makes.
But before you rush to watch stock market live and pick up shares with high PEs, proceed with caution. There are other things you should look out for while investing in the Indian share market, like growth rates in the past. If a company's growth rates in the past have been low, and its stock has a high PE ratio, there's a good chance it may be overvalued. Only if a stock has shown demonstrably high growth rates in the past is a high PE justified.
Another problem while using PE ratio is that you can't use it to compare companies across industries. For example, in the share market in India, you can't use a PE ratio to compare, say a company in the IT sector and one in cement. These industries will have different growth rates, different expectations, levels of stability and so forth.
So in general, the PE ratio is a good tool for those who want to invest in the share market. But like all other tools, it must be used judiciously and in conjunction with other indicators.
So exactly how does the PE help you make investment decisions on the share market? Generally, a stock with a high PE means that the company is expected to have higher earnings growth. Stocks whose forecasted earnings are expected to be low will have a lower PE ratio.
Before we go further, we must understand what EPS is all about. EPS is simply the amount of earning per share. It is calculated as profit divided by weighted average common shares. It is another good indication of a share's potential. High EPS means that the company is making good profits and therefore a good buy.
The price-earnings ratio shows how much investors are prepared to pay for each rupee of earnings and is useful while investing in the share market. For example, a PE ratio of 10 indicates that an investor is willing to pay Rs 100 for every Rs 10 of profits (earnings) that a company makes.
But before you rush to watch stock market live and pick up shares with high PEs, proceed with caution. There are other things you should look out for while investing in the Indian share market, like growth rates in the past. If a company's growth rates in the past have been low, and its stock has a high PE ratio, there's a good chance it may be overvalued. Only if a stock has shown demonstrably high growth rates in the past is a high PE justified.
Another problem while using PE ratio is that you can't use it to compare companies across industries. For example, in the share market in India, you can't use a PE ratio to compare, say a company in the IT sector and one in cement. These industries will have different growth rates, different expectations, levels of stability and so forth.
So in general, the PE ratio is a good tool for those who want to invest in the share market. But like all other tools, it must be used judiciously and in conjunction with other indicators.