P.E ratio stands for price to earning ratio.It is a stock valuation ratio.It gives you some idea whether you are paying too much or not for a stock.
P.E ratio=current price of the stock divided by Earning per share
P.E(TTM) indicates trailing twelve months P.E ratio.In that case EPS is calculated for past 12 months.
WHAT IS EPS(Earning per share)?
EPS=(Net income-dividends on preferred stock)divided by average outstanding shares.
Take an example,suppose ‘xyz ltd’ has a net income of Rs 1500 for last financial year.It gives a total dividend of Rs 500,and it’s total shares in the market is 100.
so,(1500-500)/100=10.It’s EPS is 10.
simply,it is how much amount of money a company earns from a single stock.
EXPLANATION OF P.E RATIO:-
As the price of the stock changes,so does the P.E ratio.It indicates whether the stock is cheap or not.
So, you must have to study about P.E ratio before investing.
Suppose the price of a stock ‘A’ is Rs-3000 & it’s EPS is 500.Then it’s P.E ratio is 3000/500=6
Now the price of the stock ‘B’ is Rs-200 & it’s EPS is 10.Then it’s P.E ratio is 200/10=20.
Which one is good for investment?obviously it is stock ‘A’,although it seems that stock ‘B’ is cheaper but from investment point of view stock ‘A’ is cheaper.Because for stock ‘A’ you are paying less amount compared to the earning from that single stock.
Now,consider the EPS remains constant for a certain period of time but the price of that stock falls due to some unfavourable market condition.It means that the P.E ratio will also fall but as the fundamental parameter(EPS) remains unchanged,it is worth to invest on that level.
Now,suppose the price of a certain stock remains range bound for a certain period of time,but the EPS increase.In that case also P.E ratio will fall.So clearly low P.E ratio stock is always good for investment.
HOW DO YOU KNOW ABOUT LOW P.E RATIO:-
There is no certain rule on that.In general,P.E ratio 10-15 is considered as good & P.E ratio below 10 is considered as best for investment.But some stock’s P.E remains 20-35 level for most of the time(like large cap IT stocks:- Infosys, TCS, HCLTech). Similarly some stock’s P.E remains below 10 for most of the time(like some large cap PSU banks). So it varies from sector to sector.
Suppose you are going to invest in Infosys. Then it is advisable to compare the P.E ratio of Infosys with other large cap IT stocks(like TCS,HCL Tech, Wipro)to find whether it is cost effective or not.You can also see the historical chart of P.E ratio to check the valuation.If you find the P.E ratio is in lower range according to last 1 year chart,then don’t miss the investment opportunity.
A WORD OF CAUTION:-
Never invest in some unpopular stocks just seeing the low P.E ratio.There are many mid cap & small cap stocks whose P.E ratio always remains 1-8 range.You must have to see other fundamental parameters(like management,balance sheet,profit & loss account,future prospect etc etc) before investing.Price to earning ratio is one of the good valuation parameter but it is not the sufficient one.
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