PRICE TO EARNING RATIO

PE ratio is one of most abused ratio in Stock markets. Very few understand the true logic and reasoning associated with it. But those who understand it , may be able to shortlist really great companies. P/E ratio = Current stock price / EPS (Earnings per share) of the year. P/E Ratio mostly is taken by just the number it is showing. For example a company with a P/E ratio of 8-10 is mostly treated as cheap by many investors but is the number enough to make that conclusion ? Similarly a company at 30 P/E ratio is also may not costly just because the number seems high. So, this is the first thing that P/E ratio shall not be concluded just by the number value alone. So how to conclude something from P/E ratio if not just the number it is showing ? We need understand few factors for it to make some conclusion out of it. Lets move on understand them one by one. Tailwinds or Headwinds (Sunrise Sector ?) So, first question one shall ask is which sector does it belong to and how are the tailwinds for the sector. Why tailwinds ? Because tailwinds would mean that the sector may see very good growth going forward for some period meaning a bit higher P/E ratio will not be a issue as the growing nos. will take care of it. Ex: Renewable energy Sector If something with potential has less P/E ratio in the same sector then that might convert into really good opportunity. Vice versal with Headwinds , even lower P/E ratio might not be appreciated by the markets. Ex: Paper sector. How much P/E is awarded to the sector generally ? Now their will be some sectors where the sector in it self is not awarded very high P/E by the markets. Ex: Broking Sector So, in such sectors P/E ratio has to be checked in sync with its historic P/E as well as the sector P/E. Example: If a stocks hitting 20-24 P/E on higher side irrespective of growth in the company may mean that market don't award higher P/E multiples. So if the P/E is 20 then it might not be very good opportunity. Value or growth Opportunity Companies where Valuations are pretty cheap and get supported by the market may give quicker moves as the fair price is already in place. whereas growth companies where companies execution and recent quarters nos. shows how much the company can do, such names may move as per the earnings to keep the P/E in check. So, to know on which bus you are getting on is also important. As if i expect quick return from growth name and manage it accordingly i might fail in it. Such factors gets very important while understanding P/E ratio of a company. Now as you go on and steady above factors might also get combined in particular sector like Value plus growth opportunity in single name. So, one has to improvise accordingly. Using the P/E ratio effectively is very important to generate super performance.