The P/E ratio (price-to-earnings ratio) of a stock is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share.High ratio indicates the share is overvalued and low ratio shows that share is undervalued.
It is computed by the following formula:
For example, if the company's share price is Rs. 40 and the earning per share is Rs. 10 then price earning ratio is 4 (i.e., 40/10). It means that the market value of every rupee of earning is four times.
It is very important ratio in order to know whether the shares of the company are undervalued or in predicting the future market price. if one stock has a P/E twice that of another stock, all things being equal (especially the earnings growth rate), it is a less attractive investment. Companies are rarely equal, however, and comparisons between industries, companies, and time periods may be misleading. P/E ratio in general is useful for comparing valuation of peer companies in similar sector or group.
NEXT - Market Test Ratios: Payout Ratio
Table of Contents
1) Market Test Ratios: Introduction
2) Market Test Ratios: Earning per Share Ratio
3) Market Test Ratios: P/E Ratio
4) Market Test Ratios: Payout Ratio
5) Market Test Ratios: Dividend Yield Ratio
6) Market Test Ratios: Price/Cash flow Ratio
7) Market Test Ratios: Price to book value Ratio
8) Market Test Ratios: Price/Sales Ratio
9) Market Test Ratios: Price/Earnings To Growth Ratio