P/E Ratio Analysis

This topic is intended for Investors who have some basics or understanding about shares. The objective of this blog is to clearly tell what P/E Ratio is and how it must be used. P/E is the price of the share for an unit of earning – as an example, if the PE Ratio is 20, it means for every dollar profit that the company is earning, the price of the share is a multiple of 20, or in other words the share price is 20 times the earnings. Now, there ends the definition.

How are we supposed to interpret it like the others? To answer that, let us take a different approach. Now what is the level of profit that you expect from your investment – let me put it as 10%. To get 10% growth from current levels of the share price, the company should grow by 10% theoretically. Now every investor will have his own assumption of the growth rate of the company and his own profit target. If the profit of the company increases, then the price is likely to appreciate further, thereby maintaining the PE level.

There are times when the PE levels fluctuate, that is because the markets react to an expected earnings at a future date. Usually a high PE indicates a good share, because market is willing to pay a higher price and vice-versa for a low PE. Now a level of 8 to 12 is generally a good level to buy (Again a word of caution here. This is only one parameter and you should also consider the other parameters).

With the favorable PE levels known, it would be prudent of the investor to look into other ratios and decide.  Now I leave it to the investor to get into thinking mode and arrive at some strategies for investing (Remember: Buy Low and Sell high)


Leave a Reply