Why is Price Earnings Ratio is Important in Stock Selection?

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pe ratio

The P/E Ratio or ‘Price to earnings’ ratio is the ratio between a stock market price and the company’s earnings from a share.

PE Ratio is the way to know that the share of the company’s income per share is the proportion of the share market. To know the PE ratio, first of all, EPS means that the share per share. After that, you can extract the PE ratio by dividing the EPS by the price of a share.

EPS=Net income available to shareholders/Number of shares outstanding

PE Ratio =Current  Market Price of the stock / EPS

Now let’s understand this, with an example. Suppose A  company ABC has 200,000 shares worth ₹10. The annual income of the company is ₹4,00,000. Now the EPS of the stock will be 4,00,000 / 200000 = ₹2. Now if the price of the current  stock in the share market is ₹18, then the PE ratio of the stock will be: PE ratio = 18/2 = 9

Read, also How Penny Stocks Can Increase Your Profit in 2019?

Reasons for Low  P/E ratio

  • Stock is undervalued
  • Low growth of -ve growth of the organization
  • Future prospects are not great

Reasons for High P/E ratio

  • Stock is overvalued
  • The high growth of the organization
  • Future prospects are great

 

Why Use the Price Earnings Ratio?

Every Investor wants to buy the stock of that Company which is financially good and offer high returns on Investment. So PE ratio is an easy tool to analyze the market prices of shares of two stocks, two Companies.

Whenever you are trying to research about the pe ratio of the company is to keep one thing in mind always never compare the pe ratio of two different industries. You can’t compare the steel industry with the Cosmetic Industry. 

Industry PE Ratio

The average PE ratio of the companies involved in one industry or industry is called Industry PE Ratio. According to the understanding of the growth of any industry, the PE ratio of that industry may be more or less. Comparing the company’s PE ratio with the PE ratio of its industry, the possibility of increasing the price of the company can also be estimated.

With the help of Industry PE Ratio, you can compare the PE ratio to their Industry PE ratio and get the idea of how the company is performing.

Conclusion

Let me make it clear here that PE ratio is just an indicator of the company belonging to that particular stock sector and it is helpful in deciding the investment as well as analyzing the fundamentals.

It is not necessary that stocks with a lower P/E are always undervalued and stocks commanding higher P/E are the best stocks.

but whenever you invest, Invest only after taking consideration of full information about the company, its industry, and the market and their trend of business.