P/E ratio
Also called: P/E, PE ratio, price to earnings, price-to-earnings
Share price divided by earnings per share: how many rupees you pay for each rupee of yearly profit.
Earnings per share (EPS) is a year’s profit divided by the number of shares. Divide the share price by EPS and you have the P/E. Turn it upside down and you get the earnings yield: the profit the business earns as a percentage of the price you pay.
A high P/E means the market expects profits to grow, or that this year’s profit is unusually low. A low P/E means the share is cheap, or that the market expects profits to fall. Working out which is most of the job.
Example
A share trades at 600 rupees and the company earned 30 rupees per share last year. The P/E is 20, and the earnings yield is 5 percent (30 divided by 600).
Watch out
Check whether a P/E is trailing (the last twelve months) or forward (someone’s estimate of next year), and compare it only with the company’s own history and its sector. Cyclical companies such as steel makers look cheapest on P/E just as their profits peak.
Learn it properly in
Chapter 1.2: P/E, P/B and ROE: three ratios that do most of the work