What is P/E Ratio? Meaning, Formula, Types & Easy Examples
The P/E Ratio (Price to Earnings Ratio) is one of the most important financial metrics used to evaluate whether a stock is overvalued or undervalued. Every investor — whether beginner or experienced — should understand how to calculate and interpret this ratio before investing in any company.
In simple words, the P/E ratio tells you how much investors are willing to pay for ₹1 of a company’s earnings.
What Does P/E Ratio Tell You?
The P/E ratio reflects market expectations. A high P/E ratio generally means investors expect higher future growth, while a low P/E ratio may indicate slower growth or undervaluation.
- High P/E = Investors expect strong future growth
- Low P/E = Stock may be undervalued or growth may be slow
- Very High P/E = Possible overvaluation
Understanding Earnings Per Share (EPS)
Before calculating the P/E ratio, you must understand EPS (Earnings Per Share).
EPS represents the company’s profit allocated to each share.
Example 1: Basic P/E Ratio Calculation
Let’s say:
| Particulars | Value |
|---|---|
| Market Price per Share | ₹500 |
| Earnings Per Share (EPS) | ₹25 |
Calculation:
This means investors are willing to pay ₹20 for every ₹1 of earnings.
Example 2: Calculating EPS First, Then P/E
Suppose a company has:
- Net Profit = ₹10 Crore
- Total Shares = 1 Crore
- Market Price = ₹150
Step 1: Calculate EPS
Step 2: Calculate P/E Ratio
The stock has a P/E ratio of 15.
Types of P/E Ratio
1. Trailing P/E
Trailing P/E is calculated using the company’s past 12 months earnings. It reflects actual historical performance.
2. Forward P/E
Forward P/E is calculated using expected future earnings. It is based on projections and estimates.
What is a Good P/E Ratio?
There is no universal “good” P/E ratio. It depends on:
- Industry average
- Company growth rate
- Economic conditions
For example:
| Industry | Average P/E |
|---|---|
| Technology | 25–40 |
| Banking | 10–20 |
| FMCG | 30–50 |
Always compare a company’s P/E with its industry average.
Advantages of P/E Ratio
- Simple and easy to calculate
- Quick comparison between companies
- Helps identify overvalued or undervalued stocks
- Widely used in fundamental analysis
Limitations of P/E Ratio
- Does not work well for loss-making companies
- Ignores company debt
- Future growth assumptions may be wrong
- Can be misleading during economic downturns
How Investors Use P/E Ratio Smartly
Professional investors never rely only on P/E ratio. They combine it with:
- PEG Ratio
- Debt-to-Equity Ratio
- Return on Equity (ROE)
- Revenue growth trends
A stock with high P/E but strong growth may still be attractive.
Practical Example Comparison
| Company | Price | EPS | P/E |
|---|---|---|---|
| Company A | ₹100 | ₹10 | 10 |
| Company B | ₹200 | ₹5 | 40 |
Company A looks cheaper based on P/E ratio. However, if Company B is growing rapidly, investors might justify paying a higher P/E.
Key Takeaways
- P/E Ratio measures stock valuation
- Formula: Price ÷ EPS
- Compare within same industry
- Use with other financial metrics
- High P/E doesn’t always mean overvalued
P/E Ratio Calculator
Frequently Asked Questions (FAQs)
1. What is the ideal P/E ratio for investing?
There is no fixed ideal P/E ratio. It depends on industry standards, company growth, and market conditions.
2. Is a high P/E ratio good or bad?
A high P/E ratio may indicate strong growth expectations, but it can also mean the stock is overvalued.
3. Can P/E ratio be negative?
No. If a company has losses, EPS becomes negative and P/E ratio is not meaningful.
4. What is better: Low P/E or High P/E?
Neither is automatically better. Context and company fundamentals matter.
5. Should beginners use P/E ratio?
Yes. It is one of the simplest tools for understanding stock valuation.
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