What Is Price To Earnings (P/E) Ratio?
Stocks belonging to a peer group are compared based on their P/E ratio to ascertain their comparative valuations.
This is a series of explainers to educate and inform new investors. In association with Dun & Bradstreet India as knowledge partner.
Price To Earning (P/E) Valuation: Definition, Meaning & Basics
Price to Earnings Ratio is a method of relative valuation of a company’s share price with its earnings per share or EPS. It is calculated by dividing the market price per share by EPS of the company. This helps in identifying how shares of a company are valued vis-a-vis peers. The P/E ratio is also referred to as price multiple or earnings multiple.
It is used for stock investment decisions. Stocks belonging to a peer group are compared based on their P/E ratio to ascertain their comparative valuations.
Stocks which have a lower P/E ratio compared to their peer group are supposed to be undervalued or cheaper while those with higher P/E than their peer group are considered as overvalued or more expensive. It is believed that growth stocks typically have higher P/E as investors are willing to accept a higher valuation for such stocks on account of their higher growth potential.
P/E ratio can be based on historical earnings or future projected earnings. In the latter case it is referred to as forward PE. Tracking a company’s PE ratio over time can help in analysis of demand for its shares relative to its performance.