The P/E ratio, or Price-to-Earnings Ratio, is a metric used to assess the valuation of a company's stock relative to its current profitability. In simpler terms, it tells you how much you are paying for each rupee of a company's earnings.

Here's the formula:

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

• Current Stock Price: This is the market price of one share of the company's stock on a particular day. You can find this on any financial website or stock exchange platform.
• Earnings Per Share (EPS): This represents the portion of a company's profit allocated to each outstanding share of common stock. You can also find this information on financial websites or in the company's annual reports.

Example 1

A company's stock price is Rs 100 per share.

The company's EPS is Rs 5 per share.

Then the P/E Ratio would be:

P/E Ratio = Rs 100 / Rs 5 = 20

This means you are paying Rs. 20 for every Rs. 1 of the company's earnings.

Example 2

Another company's stock price is Rs 50 per share, and its EPS is Rs 10 per share.

P/E Ratio = Rs 50 / Rs 10 = 5

In this case, you are only paying Rs 5 for every Rs 1 of the company's earnings.

Interpreting the P/E Ratio

The challenging part is the interpretation. So, before we go, we will talk about two points that would help you interpret the PE ratio.

• A higher P/E ratio can generally indicate that a stock is priced higher relative to its current earnings. This could mean investors are anticipating future growth for the company. However, it could also suggest the stock might be overvalued.
• A lower P/E ratio can suggest the stock is undervalued or that the company's earnings are currently high relative to its stock price. However, it's important to consider if there's a reason for the lower earnings, such as industry challenges.