PRICE - EARNINGS RATIO OR PE RATIO AND EPS
This post is about p/e ratio and eps. PE ratio is one of the important metric in valuation of a share. A malayalam video of this is embedded below this pos
PE ratio a simple explanation
I will explain pe ratio with a simple example. Consider there is a bakery ( Bakery A ) which make a profit of 1 lakh per month. Another bakery ( Bakery B ) with two lakh profit per month. Both shops are for sale at 10 lakh. Which one you will buy. Or which you think have cheap valuation or value for money. Obviously Second one ie BakeyB because it earns more. In first case we pay 10 times its earnings. In second case we pay only 5 times its earnings. PE ratio gives same information that is how much we are paying for its earnings.
What is pe ratio or price to earnings ratio
Pe ratio is got by dividing market price of a stock with earnings per share.
Pe ratio measures valuation or price of share based on its earnings. It shows how much investors are ready to pay for that stock based on its earnings.
High pe doesnt always means its costly or low pe doesnt mean its cheap. Earnings growth and other fundamentals should also be considered there.
Sometimes high pe may be due to investors are expecting huge growth and ready to pay. Some cyclical stocks have high pe at some stages of this cycle. Some sector also normally have high pe valuation. Some companies which have good brand value or a competative advantage also enjoy high valuation some times.
Low pe can be due to price drop due to some fundamental issue also.
You need to find whether that pe ratios can be justified and can it maintain this growth.
PE ratio of a stock can be campared with other stocks in same sector or with industry pe. Only pe ratio should not be used for valuation of a stock. You need to consider other fundamental aspects also during valuing a stock.
What is EPS or earnings per share
Earnings per share or eps can be calculated by earnings with number of outstanding share.
How to calculate pe ratio
Price to earnings ratio or pe ratio can be calculated by deviding market price of stock with earnings per share.
For that you first need eps. Eps formula is
EPS = Earnings / Number of outstanding shares.
This eps formula gives earning per one share.
Now we can calculate price to earnings ratio with this formula.
PE ratio formula = Market price of stock / EPS
PE ratio in bull and bear market
During bull market stock prices shoot up resulting in high PE. In bear market you can see some good stocks also at low pe due to price drop. So companies with low pe and good earnings growth can give good returns once market reverse.
Sectoral PE
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