How to read the PE ratio for smart investing
markets to analyse a stock and its valuation trajectory. ET looks at the interpretation and accuracy of PE ratio and how investors can use PE ratio to assess a stock or company.
What is PE Ratio?
PE ratio is a commonly used valuation metric by investors all over the world. It is an indicator of whether the stock market or an index or a stock is expensive or cheap.
How is PE ratio measured?
The ratio is calculated by dividing the price of a stock or an index by the earnings per share, or EPS, (net profit divided by the number of common shares outstanding). For example, if a stock is trading at ₹50 and its earnings per share is ₹10, then the PE ratio is 50/10=5. There are two types of PE ratios: Forward PE and Trailing PE. Forward PE ratio is a forward-looking ratio that measures the current stock price with the estimated future earnings. Trailing PE is the current share price divided by the last four quarterly EPS.
Is forward or trailing PE ratio more important?
A forward PE ratio is more widely used by knowledgeable investors than trailing PE. This is because stock prices tend to discount reported earnings, while the market is forward looking. That said, many investors take forward earnings into account mostly for larger companies widely covered by analysts. For small companies, forward earnings might end up being less credible, making trailing earnings a better measure to calculate PE ratio. «Trailing PE is a starting point since it is based on historical earnings,» says Shibani Kurian, head of equity research, Kotak Mutual Fund. «Typically, markets tend to look at the forward PE ratio as it is future oriented.» Kurian says a two-year Forward PE ratio is commonly used while assessing a stock or a company.
How to
Read more on economictimes.indiatimes.com
