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Price To Earning Ratio

Our Technical Team at A1 Intraday Tips has given information about Price to Earning Ratio for day traders in Nse Market. The price-earnings ratio, also known as P/E ratio, P/E, or PER, is the ratio of a company's share price to the company's earnings per share. This Ratio can be calculated for only listed companies. Its tells us how much we are paying for each Rupees of earnings. The ratio is used for valuing companies and to find out whether they are overvalued or undervalued.

Price to earning ratio is calculated by formula = Current Market Price/EPS

Price to Earning Ratio

In the above example the share price of a company listed in the nse market is Rs 100 and the annual earning per share calculated is Rs 20, So the Price to earnings ratio will be equal to 100/20 i.e. 5.

If a P/E Ratio is low, it could mean that investors are loosing the confidence and are selling the shares. A P/E ratio should always be compared with the other companies in that sector.

How P/E Ratio is Beneficial or Not for Investors.

These ratio helps investors to analyses how much they should pay for the stock on the basis of its current earning. It also shows whether the market is overvaluing or undervaluing the specific stock of that company. A stock with a rising P/E generally means investors are bullish about the stock. A stock with a declining P/E may mean the market has less confidence in the company’s future earnings growth, or it may simply be undervalued.

You can invest based on the P/E of an individual stock, but many people look at the overall P/E for a particular sector. One interpretation is that the stock market is overvalued when the P/E ratio is above average.

The important thing to remember is that there is not a set rule you can apply. You must factor in what is going on in the world. For example, if the economy is in trouble or there is a global health crisis like Corona Virus, corporate earnings can be worse than expected. This lowers investor expectations, and stock prices will go down. Even if the market seems fairly valued at a P/E ratio of 14, bad times could cause the market returns to continue on a downward spiral with the P/E ratio going much lower.

On the other hand, during booming economies, corporate earnings can continue to rise, and stock prices can increase for many years in a row. A P/E ratio of 16, or even 20, does not automatically mean the market is overpriced. In the early ’90s, many who thought the market was overvalued based on P/E ratios missed the great returns of 1994 to 1999.

Companies that grow faster than average generally enjoy higher price-to-earnings ratios (greater than 15), a reflection that investors are willing to pay more per rupees of earnings today because they expect future earnings growth to exceed that of other companies. For example, a company with a P/E ratio of 30 would theoretically earn at double the growth rate of a company with a P/E of 15. Conversely, a company with earnings growth expected to be less than average would have a lower P/E ratio (less than 15).

Limitations of Using the P/E Ratio.

This price-to-earnings ratio comes with a few important limitations that a trader/investors should know before he take decision to buy the stock. Using P/E ratios alone for investment decisions can be risky and unwise decision.

  • Market Prices : Market Prices in the Short-Term Can Be Erratic. Short-term prices in the market are driven by emotions triggered by rumors and expectation.
  • Reported Earnings : Since the P/E is calculated on the basis of Earnings, The CEO, Directors can manage the earnings to show very good results.
  • Difficult to Interpret A low P/E can mean that a company’s worth is undervalued by the market in the short-term and represents a buying opportunity for the investor. It can also mean that the company is expected to have problems in the future and lot of other smart investors/ traders would have sold the stock to avoid probable losses.

Price-to-earnings ratios are quick and easy to calculate. They are particularly useful in making immediate comparisons but its has its limitations. P/E ratios should also be used with other metrics to confirm your analysis before taking action to invest in a particular stock.

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