Have you ever done grocery shopping with your family? Did you notice how they bargain with vendors and how vendors defend their cost price? Basically, they try to analyze the correct PE ratio.
Why do they do this? Because they feel they will get better value for their money after that 10% or 20% discount…right?
Likewise, when we invest in the stock market, it is important to realize if the price at which you are buying a share is value for your money.
One of the most important parameters to check the valuation of a company is “PE ratio” or “Price-to-Earnings ratio”. But,
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What is PE ratio?
- PE ratio is the current market price of the share/earnings-per-share, which means the amount of money you pay to earn a rupee is your PE ratio.
- It basically shows the relationship between the price and earnings of the company so that you can analyze if the price is optimum in relation to its current earnings.
How PE ratio helps to analyze the value of a stock?
- Higher the PE, more money you will pay to earn a rupee and higher will be the valuation of a company. This is an ideal situation, but practically this does not hold true every time.
For example, if the PE of a company is 50, it implies that as an investor you will need to pay Rs 50 to earn Re 1 of that company.
Now, you must be thinking, even if we know the PE of the company, how can we identify if the PE is on the higher side or on the lower side?
So, the simple answer to this simple question is – ‘Comparison’.
Comparing the PE of your selected company along with that of its peers and also comparing it with your industry’s PE is the most common way to anticipate your company’s valuations.
