What is P/E ratio with respect to stocks? how is it calculated?

Answer 1

What is a price-earnings ratio?
The normal reaction when we look at share prices is?a Rs40 stock is cheap, and a Rs 1,000 stock is expensive. Let?s say we were buying onions. One subziwala said Rs 20; another said Rs 100. Would we simply jump and say that Rs 20 was a great deal? What if one was saying Rs20 for half kg of onions and another was offering 10kg for Rs100?
There?s a lesson here: Price itself is not enough?it actually takes a ratio to determine cheap or expensive. And the ratio is price per unit of whatever we are buying.
But someone might still say that stock prices are already ?per share?. So Rs40 per share and Rs1,000 per share should be comparable. This is where we need to look beyond the piece of paper (or with demat stocks, not even the paper). What are we buying when we buy a share?

When we buy a company?s share, we buy a share of the company?s profits, both current and future. As an example, let?s take HLL. During the period Jan 1998 to Dec 1998, HLL made a net profit of Rs805cr; it currently has a total of 20cr shares. Each share (and therefore its owner) owns Rs40.3 (Rs805cr divided by 20cr shares) of HLL?s net profit. This Rs40.3 is then referred to as earnings per share of HLL.

So, when we buy one share of HLL, we are buying Rs40.3 of net profit, together with the right to future net profits. If HLL were to make a net profit of Rs1000cr this year, and were to issue another 5cr shares, the earnings per share for next year would be Rs40:
Rs1000cr divided by (20cr old shares + 5cr new shares = 25cr shares) = Rs40 per share

Keeping this in mind, now let?s go back to our original problem. How do we figure out if a stock is cheap or expensive? If we buy a share for Rs1000, and the earnings per share for the company is Rs100, then we are paying Rs10 for each rupee of net profit we buy into. If we buy a share of another company for Rs40, which has an earnings per share is Rs2, then we pay Rs20 for each rupee of net profit we buy into. Which one is cheaper?

When we look at a share price, we should also look at earnings per share. Looking at both of them is the only way to determine whether the share is cheap or expensive. To make it easy for themselves, research analysts have created a simple formula:
Price Earnings Ratio = Price per share/Earnings per Share
where, Earnings per Share = Net profit /Number of issued shares
So when they want to know whether a share is cheap or expensive, they just calculate this ratio. And lower the ratio, cheaper the stock is.

Just to summarise:
When we buy a share, we actually buy a share of the net profit of the company. How much depends on two things?how much net profit it has made, and how many shares it has.
Net profit per share is called earnings per share or EPS, and is what the owner of one share is entitled to out of the total net profit made by the company.
The price per share divided by the earnings per share is the Price Earnings Ratio (PER) and is a measure of how much we pay for each rupee of net profit of the company we buy into when we buy a share.


But a low PE is not enough
Is a stock which quotes at a lower PE always a better buy? Not necessarily. Let us just step back in time to January 1998. Punjab Tractors was trading at Rs628 which placed it at a PE of 23, whereas Telco was trading at Rs300 which placed that stock at a PE of 10. So, which stock would you prefer to buy? Just take a look at the chart down below and it is quite clear that while you would have made money by buying Punjab Tractors, you would have lost money by buying Telco.
So what went wrong? The market always looks at the future, not just at the past. The PE ratios mentioned above were based on the profits (EPS) earned by the company in the year already past. But the market looks to the future. Look at the table down below and you will see that Punjab Tractors? PE is much lower when you look at its future earnings.



Punjab Tractors & Telco?A Comparison
Market Price EPS Market Price
Jan 1998 1997 1998 1999 CAGR 1999
Punjab Tractors 628 27.01 46.47 59.39 48 1061
PE 23.3 13.5 10.6
Telco 300 29.0 11.0 3.5 -65 233
PE 10.3 27.3 85.7
In the following two years, Punjab Tractors grew earnings by 48% while Telco?s EPS dropped 65%. As a result, in 1999 Punjab Tractors? PE dropped to 10.6 (on 1998 prices) while Telco?s PE went up to 85.7. Now, which one is expensive? All those who did buy into a bargain PE must be ruing their decision.
The point we are trying to convey is that the most critical factor that determines PE is future growth. Higher PEs do not always indicate an expensive stock. That?s where we use the PE?growth ratio (PEG). This ratio enables us to catch stocks with growth, at a reasonable price. The lower the PEG, more attractive the stock and vice versa. We will take up this ratio in detail the next time. We would also look at two other ratios?ROCE and RONW?that also determine PE of a stock.

Answer 2

Price-Earnings Ratio (P/E Ratio)

What does it Mean? A valuation ratio of a company's current share price compared to its per-share earnings.

Calculated as:

Marker Value Per Share/ Earnings Per Share

For example, if a company is currently trading at $43 a share and earnings over the last 12 months were $1.95 per share, the P/E ratio for the stock would be 22.05 ($43/$1.95).

EPS is usually from the last four quarters (trailing P/E), but sometimes it can be taken from the estimates of earnings expected in the next four quarters (projected or forward P/E). A third variation uses the sum of the last two actual quarters and the estimates of the next two quarters.

Also sometimes known as "price multiple" or "earnings multiple".

In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E. However, the P/E ratio doesn't tell us the whole story by itself. It's usually more useful to compare the P/E ratios of one company to other companies in the same industry, to the market in general or against the company's own historical P/E.

It would not be useful for investors using the P/E ratio as a basis for their investment to compare the P/E of a technology company (high P/E) to a utility company (low P/E) as each industry has much different growth prospects.

The P/E is sometimes referred to as the "multiple", because it shows how much investors are willing to pay per dollar of earnings. If a company were currently trading at a multiple (P/E) of 20, the interpretation is that an investor is willing to pay $20 for $1 of current earnings.

It is important that investors note an important problem that arises with the P/E measure, and to avoid basing a decision on this measure alone. The denominator (earnings) is based on an accounting measure of earnings that is susceptible to forms of manipulation, making the quality of the P/E only as good as the quality of the underlying earnings number.

Answer 3

The P/E ratio is a way certain traders measure the "value" of a stock price relative to how much the company "earned per share" of outstanding stock.

Calculation: current market price of the stock divided by the "earnings per share."

Answer 4

P/E refers to the price to earnings ratio, the current stock price divided by 12 months of earnings (per share). Most mechanically-produced P/E's use trailing 12-month figures, while analysts like myself typically use "forward" 12-month earnings estimates (for now, use the 2008 analyst consensus numbers on Yahoo finance) because the stock market is a forward barometer and I am thinking about where the stock will be in the future, not the past.

P/E is used for comparative valuation purposes. It is best when used in conjunction with other valuation measures (discounted cash flow model; cash flow yield) as part of the mosaic of analysis. For companies with minimal or negative earnings, P/E is useless, and price/sales may be more helpful. In general, high-growth stocks with momentum tend to sport high P/Es; cyclical, mature, or distressed firms tend to have low P/Es. All stocks are speculative, and a low P/E does not mean low risk, as it may also mean eroding markets, falling margins or a lack of cash.

It is critical to note whether companies are guiding earnings estimates higher or lower. Upward forward earnings revisions mean lower forward P/Es, and may indicate an important positive development that Wall Street does not yet fully appreciate. Examples include improved sales or operations, a new product cycle, or a more favorable regulatory environment.

An example of an appropriate use of P/E is when comparing competing firms with similar overall businesses- Lowes and Home Depot for a classic example. Then you want to study the firms' current strategies, management track records, cash and financial leverage (debt/capital), to see if different P/Es are justified.

Answer 5

The P/E ratio (price-to-earnings ratio) of a stock (also called its "earnings multiple", or simply "multiple", "P/E", or "PE") is a measure of the price paid for a share relative to the income or profit earned by the firm per share. A higher P/E ratio means that investors are paying more for each unit of income. It is a valuation ratio included in other financial ratios. The reciprocal of the P/E ratio is known as the earnings yield.

P/E ratio=Price per Share/Earnings per Share

Answer 6

It is an abbreviation for the term "price-to-earnings ratio." Simply put - if a stock is trading at $10 per share and the earnings of the company are $1 per share, it's P/E is 10.

Answer 7

PE means price earning ratio.
it is decided the valution of share.
it is calculted as-
P/E= MARKET PRICE OF SHARE/ EARNING
PER SHARE OF SHARE
This is the factor which decides that market price of share is fair or higher/less then it's fair value.
how will it should be in future.
it's all decided with it's comparision with the P/E of industrial group of which the company belongs. e.g.-if a pharmaceutical company ALBERT DAVID LTD.'S 2006-2007 E.P.S. IS 23/- & it's price 96/- so it's P/E is 4.45, weather pharmaceutical group industrial average P/E IS 11.4 .Means there is chance for ALBERT DAVID LTD. TO reach upto or nearto 11.4 multiplied by 23= 262/- .

Answer 8

P = price E = earnings
P/E = price divided by earnings

Answer 9

PEG= 1.25