What is P/E ratio & how’s help to pick good stock?

Price to earning ratio(P/E) is ratio which can calculate by company current share price divided by company earning per share(EPS).

Formula to calculate P/E Ratio: P/E Ratio = Company stock current market price / Earning per share

Example: Suppose current market price is Rs. 250 and Earning per share is Rs. 10, PE ratio will Rs.25.

How does P/E ratio help?

PE ratio is most widely used tools to pick good valuable stock. It’s give an idea to investor that what market are billing to pay of company’s earnings.

How P/E ratio describe to company share:

P/E ratio is high that means market are bullish on stock and except company earnings growth increase in future. Higher PE ratio stock can introduce as overpriced in some cases. overpriced means stock price is much higher compare to its real potential growth.

P/E ratio is low that means market are bearish on stock and except company earnings growth decrease. low P/E ratio stock can describe as undervalued. undervalued means market don’t know about the stock real potential growth.

Drawbacks of P/E ratio:

P/E ratio is mostly dependent on comparison of the company with its peers company. Also In some sectors P/E ratio can considered as very high while in some sectors can considered as very low.

For Example, companies in Telecom and Information Technology sectors have higher P/E ratio than the companies in Auto, manufacturing or pharmacy sectors.