How to calculate PE ratio:
Let’s look at an example to understand better. One share of a company, ABC has a market price of INR 100 on the stock market and its earnings per share is INR 20.00 then the PE ratio of the company would be 5. This means a shareholder of the company ABC will recover their investment in 5 years provided the earnings remain constant and no further shares are issued for the next 5 years.
Importance of PE in analysis of investment opportunities:
By the logic stated above, one may think that a low PE ratio is beneficial but it may not be the case since the market price per share may be lower than the company’s potential. Exactly opposite may be the case for a high PE ratio wherein market price of the share is higher than its actual potential and in spite of having high EPS, the company might still have a low PE.
Like EPS, PE ratio is also a complementary tool in analysing investment opportunities. PE ratio, clubbed with other market ratios and analysis is useful in understanding the potential of a particular company. Comparison with a competitor’s PE can also prove useful to understand the potential of a company in the long term perspective.