PE Ratio: Types of Price to Earning Ratio & Its Calculation | Mirae Asset (2024)

Price to Earnings Ratio or Price to Earnings Multiple is the ratio of share price of a stock to its earnings per share (EPS). PE ratio is one of the most popular valuation metric of stocks. It provides indication whether a stock at its current market price is expensive or cheap. Let us explore what is PE ratio, its different types and how to use them in investment decisions.

Significance of PE ratio

What does PE ratio mean?

The earnings of stock (EPS) can either be distributed to shareholders as dividends or re-invested in the business to grow revenues and EPS in the future leading to capital appreciation. PE ratio is the price investors are willing to pay for Rs 1 of EPS of the company. If earnings are expected to grow in the future, the share price goes up and vice versa. If the share price grows much faster than the earnings growth then PE ratio becomes high. If the share price falls much faster than earnings, the PE ratio becomes low. A high PE ratio means that a stock is expensive and its price may fall in the future. A low PE ratio means that a stock is cheap and its price may rise in the future. The PE ratio, therefore, is very useful in making investment decisions.

Types of PE ratios

We discussed what is PE ratio? Let us see their types -

  • Trailing Twelve Months (TTM) PE: TTM PE is the current share price divided by the last 4 quarterly EPS. TTM PE is easy to calculate because companies declare the financial results including EPS every quarter.
  • Forward PE: Forward PE is the current share price divided by the projected EPS over the next 4 quarters. Calculating forward PE requires expertise because it involves forecasting sales, margins, P&L and EPS. Research analysts estimate forward earnings and PE ratios based on guidance received from company management and their own research.

Forward PE is more relevant than TTM PE because past earnings (EPS) are already discounted in share prices whereas forward earnings can provide indications of future stock price changes. That said, time series analysis of TTM PE can also provide useful insights into whether a stock price is getting overheated. TTM PE can also provide insight into whether the overall market or market index is too high or low when compared to past PEs.

Absolute PE versus Relative PE

  • Absolute PE: The PE ratios calculated by using any of the two methods described above i.e. TTM PE or Forward PE is known as absolute PE. This is most widely quoted PE ratio in media. However, absolute PE ratio by itself has some limitations. The most major limitation of absolute PE is that stocks in different industry sectors trade in different valuation ranges. For example, PE ratios of metal stocks are usually much lower than PE ratios of FMCG stocks, but this does not mean that metal stocks are cheaper than FMCG stocks and therefore, more attractive. This limitation of absolute PE is overcome by using relative PE.
  • Relative PE: Relative PE compares the current absolute PE to a range of past PEs over a relevant time period, such as the last 10 years. Relative PE usually compares the current PE value to the highest value of the range. For example, if the highest PE ratio of a stock in the last 10 years was 30 and the stock is currently trading at a PE of 27, then its relative PE will be 0.9.

What is a good PE ratio?

As mentioned earlier, stocks in different sectors trade in different valuation (PE) ranges. Usually stocks with higher earnings growth potential have higher PE ratios. Therefore, we cannot use a single PE level across all stocks to infer whether the price is attractive or not. You should look at historical PEs of a stock and see if the current PE is near the higher end of the range or near the lower end of the range. If the stock is trading near the lower end of the range then it can be a good investment opportunity subject to other factors which we will discuss later.

As far as Nifty is concerned, it has traded in a PE range of 10 to 30 historically. Average PE of Nifty in the last 20 years was around 20.* So PEs below 20 may provide good investment opportunities; lower the PE below 20, more attractive the investment potential.

Source- NSE India

Conclusion

In this article, we discussed what is PE ratio, what is good PE ratio, its different types and how it is used in investment strategies and its limitations. PE ratio is a great metric for stock and index valuation, but mutual fund managers use it in conjunction with various other decision factors like sustainable business model evaluation, competitive advantage, market share growth potential, earnings growth prospects, low to moderate debt equity ratio and strong management team.

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PE Ratio: Types of Price to Earning Ratio & Its Calculation | Mirae Asset (2024)

FAQs

PE Ratio: Types of Price to Earning Ratio & Its Calculation | Mirae Asset? ›

What is PE Ratio? Price to Earnings Ratio or Price to Earnings Multiple is the ratio of share price of a stock to its earnings per share (EPS). PE ratio is one of the most popular valuation metric of stocks. It provides indication whether a stock at its current market price is expensive or cheap.

How many types of PE ratio are there? ›

There are two types of P/E: trailing and forward. The former is based on previous periods of earnings per share, while a leading or forward P/E ratio is when EPS calculations are based on future estimates, which predicted numbers (often provided by management or equity research analysts).

What are the different formulas for PE ratio? ›

P/E Ratio is calculated by dividing the market price of a share by the earnings per share. P/E Ratio is calculated by dividing the market price of a share by the earnings per share. For instance, the market price of a share of the Company ABC is Rs 90 and the earnings per share are Rs 9 . P/E = 90 / 9 = 10.

How are PE ratios calculated? ›

The P/E for a stock is computed by dividing the price of a stock (the "P") by the company's annual earnings per share (the "E"). If a stock is trading at $20 per share and its earnings per share are $1, then the stock has a P/E of 20 ($20/$1).

What is the PE to price ratio? ›

Price to earnings ratio, or P/E, is a way to value a company by comparing the price of a stock to its earnings. The P/E equals the price of a share of stock, divided by the company's earnings-per-share.

What are the three types of PE? ›

Deep Vein Thrombosis and Pulmonary Embolism

Acute PE can be subdivided into three major categories: (1) massive PE, (2) submassive PE with normal blood pressure and right ventricular dysfunction, and (3) PE with normal blood pressure and preserved right ventricular function.

Why are there different PE ratios? ›

A stock's price-to-earnings ratio, or P/E ratio, is an expression of how expensive a stock is relative to the profits generated by the underlying company. Because of factors such as risk and growth rate, P/E ratios of different companies often vary considerably.

What is the most common PE ratio? ›

To give you some sense of what the average for the market is, though, many value investors would refer to 20 to 25 as the average P/E ratio range.

What is the fundamental PE formula? ›

The P/E ratio is calculated by dividing the market value price per share by the company's earnings per share. A high P/E ratio can mean that a stock's price is high relative to earnings and possibly overvalued. A low P/E ratio might indicate that the current stock price is low relative to earnings.

What are the formulas for PE? ›

The formula for potential energy depends on the force acting on the two objects. For the gravitational force the formula is P.E. = mgh, where m is the mass in kilograms, g is the acceleration due to gravity (9.8 m / s2 at the surface of the earth) and h is the height in meters.

How do you determine a good PE ratio? ›

Average PE of Nifty in the last 20 years was around 20. * So PEs below 20 may provide good investment opportunities; lower the PE below 20, more attractive the investment potential.

How do you calculate PE and PB ratio? ›

The P/B ratio, or price-to-book ratio, is calculated by dividing the market price per share by the book value per share of a company.

How do you calculate PE ratio in a portfolio? ›

The absolute P/E ratio, often referred to simply as the P/E ratio, is the normal PE ratio calculated by dividing the current market price of a company's stock by its earnings per share (EPS) for a specific period.

What is a bad PE ratio? ›

Typically, the average P/E ratio is around 20 to 25. Anything below that would be considered a good price-to-earnings ratio, whereas anything above that would be a worse P/E ratio. But it doesn't stop there, as different industries can have different average P/E ratios.

What is PE ratio ratio? ›

The price-to-earnings (P/E) ratio is the proportion of a company's share price to its earnings per share. A high P/E ratio could mean that a company's stock is overvalued or that investors expect high growth rates.

What is the formula for ratios? ›

Ratios compare two numbers, usually by dividing them. If you are comparing one data point (A) to another data point (B), your formula would be A/B. This means you are dividing information A by information B. For example, if A is five and B is 10, your ratio will be 5/10.

Which PE ratio is better? ›

Average PE of Nifty in the last 20 years was around 20. * So PEs below 20 may provide good investment opportunities; lower the PE below 20, more attractive the investment potential.

What is the difference between forward PE ratio and trailing PE ratio? ›

Key Takeaways. Trailing P/E is calculated by dividing the current market value, or share price, by the earnings per share over the previous 12 months. The forward P/E ratio estimates a company's likely earnings per share for the next 12 months.

What is the difference between PEG ratio and PE ratio? ›

While the P/E ratio is more commonly used by investors, the PEG ratio improves upon the P/E by incorporating earnings growth estimates. This provides a fuller picture of a company's relative value in the market.

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