pe ratio Understanding Price Earning Ratio to Assess a Shares

The Price to Earnings ratio is by far the most well-known financial measure. Investors regularly examine a stock’s P/E, and due to its overwhelming popularity, it can be labelled as the ‘financial ratio star’.

To understand the P/E ratio, it is important to comprehend the Earnings Per Share (EPS). The calculation of the P/E involves dividing the current stock price by this figure.

To work out this company’s earnings per share (EPS), you would divide the total profit of Rs.200000/- by the number of shares outstanding, which is 1000. This gives a result of Rs.200/- earnings per share.

=200000 / 1000

= Rs.200 per share.

Therefore, the EPS gives us an understanding of the profits earned per stock. The higher it is, the more beneficial it will be for those investing in it.

The Price-to-Earnings ratio (P/E) is a way of measuring how much market participants are willing to pay for a stock based on its earnings. For example, if a firm’s P/E rate is 15, it signifies that investors are ready to part with fifteen rupees for each rupee of profit the company earns. Generally speaking, stocks with higher P/Es are more expensive.

Let us calculate the P/E for ARBL. 

PAT = Rs.367Crs

Total Number of Shares = 17.081 Cr

PAT divided by Total no. of shares = EPS

 

= 367 / 17.081

= Rs.21.49

Current Market Price of ARBL = 661

Hence P/E = 661 / 21.49

= 30.76 times

For every unit of profit ARBL produces, investors are prepared to offer Rs.30.76 for its stock.

Assuming ARBL’s price jumps to Rs.750 while the EPS remains constant at Rs.21.49, the P/E would then be 34.77.

= 750/21.49

= 34.9 times

The EPS remained unchanged at Rs.21.49 per share, yet the stock’s P/E increased; what do you think caused this?

The P/E Ratio grew in line with the stock price as expectations for the company strengthened.

Keep in mind that the P/E Ratio is calculated using ‘earnings’. It is essential to keep certain factors in mind when examining this figure, such as:

  1. P/E shows the degree to which a stock is priced high or low. I don’t recommend buying stocks that are trading at exorbitant levels – in my opinion, 25 or 30 times earnings is the cut-off mark, regardless of what sector the company operates in.
  2. The denominator in the P/E ratio is the ‘Earnings’, which can be manipulated.
  3. Frequent changes in accounting policy can be a sign of attempted earnings manipulation. Ensure this isn’t the case for the company.
  4. Be mindful of how depreciation is accounted for. Allocating lower amounts for depreciation can result in higher profits.
  5. If profits are on the up, but there’s no evidence of a corresponding rise in cash flows and sales, there appears to be a problem.

– The Index Valuation

The price-to-earnings (P/E), price-to-book (P/B), and dividend yield ratios are crucial in determining the valuations of stock market indices such as the BSE Sensex and CNX Nifty 50. Exchanges typically provide updates of this valuation on a daily basis, giving us an indication of how costly or affordable the market is trading at. To calculate the P/E ratio for the CNX Nifty 50 Index, The National Stock Exchange adds together the capitalisation amount for all fifty stocks before dividing it by the combined earnings of these stocks. Monitoring this figure gives us insight into the sentiment of market players.

 

Take note of the following points:

  1. The peak valuation of the Index was 28x in early 2008, which was subsequently followed by a severe market crash in India.
  2. The corrections caused the valuation to drop to nearly 11x at the end of 2008 and the beginning of 2009, the most minimal valuation the Indian market had seen in recent memory.
  3. The Indian Indices Price-Earnings (P/E) ratio is typically between 16x and 20x, with an average of 18x.

After examining the evidence, it seems clear that a few important conclusions can be drawn.

  1. It is wise to exercise caution when investing in stocks if the market’s price-to-earnings ratio stands at more than 22x.
  2. When investing, it’s historically beneficial to take advantage of market valuations that are 16x or less. Taking this approach has proven to be successful in the past.

The Index P/E can be easily located on the National Stock Exchange website daily.

To access historical data for P/E, P/B, and Div ratios on the NSE website, navigate to the homepage and follow the path: Products > Indices > Historical Data > P/E, P/B & Div > Search.

In the search field, simply type in today’s date to get the most recent P/E evaluation of the market. Remember that the NSE renews this data at 6:00 PM each day.