How to Use Price-Earning (P/E) Ratio

Price-earning (P/E) ratio is frequently used by investors in taking investment decisions. It is used to determine the worth of a company’s stock. P/E ratio is the ratio of the market price of a share and earning per share.

Price-earning (P/E) = Market Price of Share / Earning per Share

For example, if the price of a stock of a company is Rs 400 and earnings per stock is Rs 20 in a year or in last 6 months then PE ratio is 20 (Rs. 400 / Rs. 20 ).

You can’t use P/E ratio of a company a lot by itself. It becomes useful while you compare the P/E ratios of different companies present in the same industry or a company’s own past P/Es.

Generally, a company with a high P/E ratio proves as costly while compared with a company with a low P/E ratio present in the same industry, as with a high P/E ratio investors pays larger multiple against company’s earnings they get.

As P/E comes in multiple so it shows how much investors are keen to pay per unit of earning. If P/E ratio of a company is 30, it means that an investor is willing to pay Rs. 30 for Rs. 1 of current earnings.

A high P/E ratio means, investors are expecting higher growth in the future.  P/E ratio of 20-25 times is determined as average. P/E ratio is only calculated for profit making companies.