Price Earnings Ratio Definition and Analysis
Price Earnings Ratio Definition – “The current price of a share of stock divided by the previous 12 months’ earnings per share. This ratio helps you compare stocks’ value.
This ratio is known from various names such as Price to earnings ratio or P/E ratio. It calculates the price of the stock with respect to its earnings. This is done through comparing the market price of the share with the earnings per share.
In simple words, the ratio tells about how much the market is willing to pay on the share on the basis of its earnings. This is used to find out the intrinsic value that is the real worth of the share. Then this real worth is compared with market value of the stock. If the intrinsic value is high then the market price, then stock is under priced. Similarly, if market value of share is high then the stock is over priced. Investors use price earnings ratio as a tool to know which stock is profitable.
In addition to this, P/E ratio is also known as price multiple or earning multiple. Because this ratio is very helpful in telling the actual worth of the stock.
P/E Ratio = Market Value per share/ Earnings per share
Price Earnings Ratio Example
To understand price earnings ratio definition more clearly, let’s discuss an example. State Bank of India is trading currently say, at Rs. 293. The earnings per share is Rs. 5. Therefore the P/E ratio of SBI:
Price earnings ratio = 293/15
This implies that the investors are willing to pay 20 rupees for every rupee of earnings. It is indicates that stock is trading at a price multiple of 20.
Price Earnings Ratio Analysis and Interpretation
Price to earnings ratio indicates the intrinsic value that is the real worth of the share on the basis of earnings made by it. When the earnings per share rises, the market value of the share also rises. An organization having high P/E ratio is considered good and investors are willing to pay for acquiring the share of that company.
Similarly, if the P/E ratio is lower, then for the investors, it is the indication of poor financial future performance. The lower Price earning ratio also indicates that company is incurring losses. One more important thing to note is that, this ratio brings about correct results, if companies within the same industry are compared.
Related Financial Terms of P/E Ratio
- Valuation Definition – Procedure and Importance
- Earnings Per Share Definition – EPS Formula, Example, Interpretation