Price to Earnings Ratio (P/E Ratio)

The P/E ratio is a simple way to figure out how expensive or cheap a company’s stock is on the basis of its profits. It typically compares earnings per share (EPS) of a company with its current market price. In other words, a P/E ratio says a lot about you how much investors are ready to pay for every ₹1 the company earns.

Key Formula:

P/E Ratio = Stock Price ÷ Earnings Per Share (EPS)

What It Shows

High P/E Ratio: Means investors feel that the company can grow a lot in the future, so they’re ready to pay more for each share.

Low P/E Ratio: Hints that investors may not feel strongly confident in future growth of the company. Hence, such stocks may be cheaper.

Example:

Suppose an AB company’s stock price is ₹100. Now, let’s take ₹5 as the current EPS.

P/E Ratio of AB = ₹100 ÷ ₹5 = 20

What does it mean?

Every investor is paying an additional ₹20 for every ₹1 the company earns.

Why the P/E Ratio Matters

Mainly, P/E ratio lets investors study overvalued or undervalued stocks easily. But keep in mind:

• A high P/E doesn’t always mean the company is great.
• A low P/E doesn’t always mean the company is bad.

It’s just one tool to compare different companies.

Types of P/E Ratios

1. Trailing P/E Ratio

This looks at the company’s past earnings, usually from the last year. It shows how much you’re paying for the money the company has already made.

Formula:

Trailing P/E = Stock Price ÷ Past Earnings Per Share

2. Forward P/E Ratio

This uses future earnings estimates. Forward P/E ratio tells investors how much they are agreeing to pay potential future earnings of a company.

Formula of Forward P/E = Stock Price ÷ Projected Earnings Per Share

Why Both Types Matter

• Trailing P/E: Based on actual past performance, so it’s reliable but doesn’t show future potential.
• Forward P/E: Focuses on future predictions, which can be helpful but aren’t always accurate.

The P/E ratio, whether trailing or forward, is a handy tool for comparing stocks and making smarter investment decisions.