PE Ratio - Useful tool to analyse stocks

Hello friends,
Time to share some more knowledge with you.
Today, we will talk about P/E Ratio. You must have heard this term a lot of times. I will explain you how to calculate P/E Ratio and what needs to be interpreted from this term.

P/E Ratio = Price to Earnings Ratio. It explains the relationship between a stock a stock price and company’s earnings. Research Analysts (God’s creations, which we see on CNBC and NDTV Profit) also refer this term as “Price Multiple” or “Earnings Multiple”. It is one of the important metric of Stock price analysis. But we cannot completely depend on this metric.
P/E Ratio = (Market Value per Share)/ (Annual Earnings per Share)
Market Value per Share = Current market price of the stock
The annual earnings per share is the net income of the company for the most recent 12 months period divided by number of outstanding shares of the company.
Annual Earnings per Share (EPS) = Net Income / No. of Shares
Example: Reliance Industries Limited is having a share price of Rs. 1100/- and its EPS is Rs. 48. Then the P/E Ratio of RIL would be 22.92 (1100/48).

But what does P/E Ratio explain?
First thing, P/E Ratio gives you an idea of what the market is willing to pay for the company’s earnings.

Some Interpretations are:
• Higher P/E = Means market is willing to pay more for the company’s earnings.
Example: P/E Ratio of Reliance Industries Ltd is 22.92 and P/E Ratio of L&T is 28.95. It means market is willing to pay more for L&T as compared to RIL.
• But, some investors look at it in a different way. They will say L&T is overpriced as compared to Reliance Industries Ltd.
• A low P/E Ratio may indicate “Sign of no-confidence” by the market which means the investors have undervalued the stock due to lack of confidence in its future growth. However, it could also mean that this is a stock which has been overlooked by the market and does possess strong future growth potential.
• A low P/E ratio stock can become a “Value pick” before the rest of the market discovers its true value.
• One cannot be very sure of movement of stock depending on P/E Ratio only. It can be used as one of the tool to analyze the stocks. In future blogs we will discuss about other analyzing tools.

Do not depend only on P/E Ratio, but use this as a very directive tool. You can compare PE Ratio of a company with its Earnings Growth rate. The PE Ratio should match the Growth rate of company. If it is matching the growth rate then you can call it as fairly valued stock. If Growth rate is more than PE Ratio, means the company is undervalued. If Growth rate is less than the PE Ratio, then the company is overvalued.
To know the PE Ratio of company, you can visit the following URL
http://www.kotaksecurities.com/jsp/EquitySearch.jsp and then type the name of the company. You will be able to see all the details of that stock.

And now something interesting. Watch this video, it is not related to our blog. But still want to share it with all of you.
http://economictimes.indiatimes.com/tv/TED-India-Pranav-Mistry/videoshow_ted/5231080.cms

Happy Learning,
Parimal.