P/E stands for Price Per Earning of a share. Meaning it is the valuation of the Current Market Price of a Share relative to its earnings per share as per the audited balance sheet.
Example:
Let’s say a company ABC is trading at a share price of Rs.200 per share in the secondary market. Let’s say there are totally 10000 shares being traded in the market. If the company had made a profit of Rs. 1,00,000 in the last four quarters after tax and all auditing, then the EPS, earnings per share will be 1,00,000/10,000 which is Rs.10.
Now P/E is calculated as Rs.200/Rs.10 which equals to 20. What this means is, the company is currently trading at 20 times its earnings per share.
Why is P/E an important metric?
P/E is a very useful data to determine the strength of the company. Higher P/E means there is a good interest in the company from the investors and the company is a good future investment. Lower the P/E means the company is doing well but is currently undervalued. As a rule of the thumb, never invest in a share based on only one indicator. You need to look at all other important metrics before making an investment decision.
Important Points:
-
Generally a P/E of 20-25 is considered as good for a company
-
If the company is not making any profit, P/E will be negative, but is generally represented as N/A
-
Higher P/E means, the investors are interested in paying more per share of the company relative to its earnings.
