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Price - Earnings Ratio (P/E)

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How much do you pay for one rupee of a company's earnings? This is what the price to earnings ratio, or PE ratio, tells us. For example, a stock with a PE ratio of 20 means you are paying 20 rupees for one rupee of earnings. The PE ratio is most widely used measure of a stock's value. The higher the PE, the more you are paying for a rupee of earnings, and the more expensive the stock.

PE ratios come in two flavors. First, the trailing PE uses the prior 12 months of earnings. Second, the forward PE uses the expected earnings for next 12 months. The forward PE is usually a better indicator, but is more uncertain since future earnings have to be estimated.

PE ratios are used for two purposes. The first is to compare similar stocks, for example two stocks in the same industry. The stock with the lower PE is cheaper, and could be a better investment. The second is to compare a stock or index with itself over time. If the PE is low relative to its historical levels, that is a potential buy signal.

That said, using the PE ratio has its pitfalls. If you see a stock with a low PE, think about why the PE is low. If its low because the outlook for the company is poor (e.g. earnings are going to fall), then you should avoid that stock.

Now, the PE could be low because prices are temporarily down. For example, market sentiment may be bearish. If the company's earnings are solid, then you may have a bargain on your hands.

These are exactly the kind of stocks the Equitymaster research teams looks for.

The Price - Earnings Ratio Formula

The PE ratio is the market price per share divided by the earnings per share. The market price per share is simply the stock price. If you want the trailing PE, the earnings per share can be found on the most recent income statement. If you want the forward PE, you use estimated future earnings per share.

PE ratio = market price per share / earnings per share

Calculating the Price - Earnings Ratio, An Example

Suppose Bajaj Auto's current stock price is Rs 3,135. And their most recent earnings per share is Rs 134. Using our formula gives us a PE ratio of 23.4.

Bajaj Auto PE = Rs 3,135 / Rs 134 = 23.4

Comparing Price - Earnings Ratio with Other Indicators

How does the PE ratio compare to other indicators, such as price to book value (PBV) or price to sales (PS)? When we buy shares in a company, we are buying into their future earnings. After all, earnings is what is left for shareholders once all expenses are paid. Thus, the PE ratio is usually the most relevant for investors. However, there may be cases where other indicators are more useful. For example, if a company is close to liquidation (when all assets are sold off and liabilities are paid), the PBV is the better indicator. This is because if a company is liquidated and stops operating, shareholders are left with the book value of the firm.

One downside of the PE ratio is that earnings can be manipulated. One off charges, depreciation, accruals, and various accounting anomalies can impact the bottom line. On the other hand, sales, or revenues, are more difficult to manipulate. The PS sales ratio is cleaner than the PE ratio, and can be a better indicator of the company's overall health. This is especially important if we are trying to gauge underlying demand for the firm's product. If there is a big divergence between the PE and PS ratio, this could be a sign that the reported earnings are not reliable.

Sometimes the PE ratio can be of no use at all. If a company made losses, earnings are negative, and so is the PE ratio. A negative PE ratio has no useful interpretation. When this happens, you should use other indicators such as PBV or PS.

Price-Earnings (P/E) Financial Ratio Analysis

The price/earnings ratio is the ratio of a company's stock price to the company's earnings per share. Find out how this ratio is calculated and how you can use it to evaluate a stock.

India's Most Attractive Companies Based on Price to Earnings Ratio

In this live data section, you can find the stocks with the most attractive PE ratios.

ORBIT EXPORTS 3.6  More Info 
HPCL 4.6  More Info 
G.E.SHIPPING 5.6  More Info 
EICHER MOTOR 5.9  More Info 
COAL INDIA 6.4  More Info 
BANK OF BARODA 7.2  More Info 
OIL INDIA 7.6  More Info 
J KUMAR INFRA 8.1  More Info 
JK PAPER 8.2  More Info 
LIC HOUSING 8.7  More Info 

The Stock Screener runs on Equitymaster's own database, which comprises India's leading 128 companies.
*Data is consolidated wherever applicable

>> Here's the full list of India's most attractively valued companies

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