Financiual Mgmt

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ABHINANDAN JAIN (Querist)
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25 September 2010 Meaning of P/e ratio and its significance
If the co is having a P/e ratio of 20,then what does it denote and also 20is expressed in what like yrs, time, %,etc?

Kishore Kumar Pahuja

Kishore Kumar Pahuja (Expert)
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26 September 2010 A valuation ratio of a company's current share price compared to its per-share earnings.

Calculated as:
Market Price Per Share/Earning per share

It is a number only reflcting how many times is the market price of the share as comapred to the earning per share. It is only a number and not denoted in any unit. Sometimes x is put as a suffix to the number to show that PE is so much times of EPS.

CA Kishore Kumar Pahuja

Sachidanand Singh

Sachidanand Singh (Expert)
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26 September 2010 Some time back cows (milch cattle) were traded at1000 per liter. (I do not know the current rate but I am sure it would be higher). What this rate meant that value of a cow that gives 1 liter of milk daily would be1000 and of another that gives 12 liters daily would be 12000.

Now think of an equity share as an income generating asset just like a cow. Whereas the cow gave milk the share gives earnings - shareholder participates proportionately in the earning of the company. The earning of the company divided by outstanding number of shares gives earning per share or EPS.

These shares are traded in the market. PE ratio is the ratio of market price divided by earning per share. Just as 1000 (in the cow example) was the ratio of trading price of a cow divided with the number of liters of milk it delivered a day, PE ratio is the ratio of market price and the annual earnings of a share. Since both earnings and market price of a share are in rupees we have rupees in both denominator and numerator that get canceled and we get a number without units; unlike in the cow example where the earning is in liters of milk but price is in rupees and we get the PE ratio of a cow in Rupees per Liter.

What does it denote? It denotes how much the market is valuing the earnings of the company. You will find that FMCG marketing companies (Colgate, HUL) etc have much higher PE ratio than say cement makers like Shree Cement and ACC. Market men rate the earnings of FMCG firms more valuable than those of cement manufacturers. The reason usually is a lot of the earnings of cement makers gets absorbed in investments in new facilities. Unlike the cement makers the FMCG marketing companies need relatively little investment in plant and machinery to grow and thus more of their earnings comes to shareholders. Also cement business has markedly more cyclicality than say toothpaste. We will brush our teeth even during recessions but most of construction activities will suffer sever slow down during recessions. Thus cement manufacturers' earnings are less stable than those of toothpaste makers. High PE ratio indicates that teh mix of growth and stability is better for that company.

Thus some sectors have higher PEs and some others have lower PEs. Within a sector low PE for a firm means the market does not think that it would grow quite as well as others. Some pople think that low PE denotes under-priced shares and thus a buying opportunity. This is debatable. If it were truly a buying opportunity others would have bought it; if the market is rating its price low it is because its value is indeed low and there is no buying opportunity. (After all it is difficult to believe that only we have noticed that its PE ratio is low.).

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CMA Amit Varma

CMA Amit Varma (Expert)
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30 September 2010 P/E ratio shows whether the stock is cheap or not interms of valuation...
say if two stock have Earning per share is Re 1 and share A is traded at Rs. 2 and share B at Rs 4...
then P/E ratio of A is 2 and of B is 4 that shows that stock A is cheaper thatn B...