PE ratio
Price to Earnings Ratio
The PE ratio tells you how many years of current earnings you are paying for a share. It is the most used, and most misused, valuation ratio.
Formula
PE
PE = Share Price ÷ EPS
Benchmark: Judge against the company's own history and its profit growth, not a fixed number
Reading the number
The self-check question is simple: would you buy a shop for ₹70 that earns you ₹1 a year? A PE of zero means the company is loss-making, because there are no earnings to divide by. PE also changes every day, because the price does, so it is a reading, not a fixed characteristic.
Using PE properly takes three steps.
- Compare the current PE with the company's own history. Look at the 6 month, 1 year, 3 year, and 5 year plus charts. A PE at the top of its own range is the first sign of "expensive".
- Do not stop there. Set the PE history against the profit growth history. A higher PE is justified when the company is now growing profit faster than it used to.
- Look for the ideal setup. Profit growth accelerating from the 5 year average to the 3 year average to the latest year, while the PE is falling. A company that once traded at 50 times earnings with 10 percent growth, and now delivers 20 percent growth at 30 to 40 times, is the attractive combination.
Indian example
Related ratios
Glossary terms
From the research
A Comparative Financial Analysis of Three Listed Companies
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