Have you ever wondered what the PE ratio in the share market is? If you’ve been dabbling in fundamental analysis, chances are, you may have come across this term as well as others, like the Earnings per Share (EPS).
Both the Price to Earnings ratio (PE ratio) and the EPS of a share are important metrics that long-term investors need to look into. The EPS tells you how profitable a company is, while the PE ratio indicates how a company’s stock is valued relative to its earnings.
To understand the EPS and PE ratios in the share market, look at the formula used for each of these financial indicators.
The EPS is that portion of a company’s profits that can be assigned to each outstanding share in the company. It can be computed using any of the following two formulas.
The first formula is more commonly used. For example, let’s say company's net income after taxes is ₹80 lakhs, and the company has ₹8 lakh outstanding shares. So, the EPS would be ₹10 per share.
The PE ratio is another financial metric used in fundamental analysis. It evaluates the market price of a company’s shares relative to its earnings. The PE ratio is computed using the formula shown below.
For instance, say the current market price of a company’s shares is ₹1,500. And its EPS is ₹100. The PE ratio will thus be 15 (i.e. 1,500 ÷ 100). This effectively means that investors are willing to pay ₹15 for each rupee of the company’s earnings.
Knowing what the EPS and PE ratios in the share market are and how to calculate them is not enough. You need to know how to decode them.
Typically, the higher the EPS, the better because it indicates good profitability per share. On the other hand, a high PE ratio indicates that the stock is overvalued and may correct itself in the future. Conversely, a low PE ratio could suggest a future price rise since the stock is undervalued.
Now that you know the EPS and PE ratios in the share market, you can use them to evaluate a stock before investing in it. The EPS tells you how profitable a company is, while the PE ratio of stocks tells you if they are overvalued or undervalued. These metrics are important whether you plan to invest in domestic or international markets. Speaking of, if you want to diversify your portfolio across US markets, the Fi Money app can help. You can instantly buy the top US stocks at zero brokerage and industry-best forex rates on the app.
The PE ratio in the stock market is not computed for the market as a whole. Instead, it is calculated for each company individually. So, there is no blanket market PE ratio as such.
A PE ratio of 30 indicates that the stock price is 30 times the company's earnings. This may or may not be a good metric, depending on the industry average and the general market conditions. While there is no hard and fast rule about a good PE ratio, investors generally consider a lower PE ratio as the better option.
A high PE ratio means the company’s stock is expensive relative to its earnings. This indicates that the company is overvalued and that the stock price could fall in the future.
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