PE Ratio and PS Ratio

PE meaning in share market

The P/E Ratio, short for Price to Earnings Ratio, indicates the relationship between a company's current share price and its earnings per share (EPS). This metric allows analysts and investors to gauge the valuation of a company's stock. While earnings from various periods can be used in the calculation, the most prevalent choice is the company's earnings from the past year. Sometimes termed as earnings multiple or price multiple, it serves as a key tool in evaluating investment opportunities.

P/E Ratio Formula

The Price to Earnings Ratio (P/E Ratio) stands out as a cornerstone metric embraced by analysts and investors worldwide. It elucidates the amount an investor is ready to allocate for a single share of a company relative to its earnings of Re. 1. For instance, if a company boasts a P/E Ratio of 20, investors are inclined to invest Rs. 20 in its stocks for every Re. 1 of their current earnings.

 

Thus, a high P/E Ratio may suggest that a company is either overvalued or poised for growth. An alternative perspective on a high P/E ratio could imply that the company is anticipated to witness increased revenue in the future, prompting speculation among analysts and investors and consequently driving up its current stock prices.

 

Conversely, a low Price to Earnings Ratio indicates undervaluation of stocks, potentially owing to systematic or unsystematic market risks. Another interpretation of a low P/E ratio could signify anticipated poor performance by a company in the future, leading to a decline in its present stock prices.

Types of Price to Earnings Ratio

There are primarily two types of Price to Earnings Ratio (P/E Ratio) that investors consider: forward P/E ratio and trailing P/E ratio. These ratios differ based on the nature of earnings they incorporate.

 

1. Forward P/E Ratio:

This ratio is computed by dividing the price of a single unit of a company's stock by the estimated earnings of the company derived from its future earnings guidance. As it relies on the future earnings outlook of a company, it's also known as the estimated P/E Ratio. Investors utilize the forward P/E Ratio to gauge the anticipated performance and growth trajectory of a company.

2. Trailing P/E Ratio:

The trailing P/E Ratio is the more commonly used metric among investors. It takes into account a company's past earnings over a specific period. This ratio offers a more precise and objective assessment of a company's historical performance.

Understanding a Good P/E Ratio

Determining what qualifies as a good or safe Price to Earnings (P/E) ratio can be tricky for investors. The judgment depends on market conditions, industry standards, and specific industry characteristics.

When comparing P/E ratios, investors should consider similar companies in the same industry and growth phase.

For example, if Company A has a P/E ratio of 40 and Company B, with similar traits, has a ratio of 10, investors pay Rs. 40 and Rs. 10, respectively, for Re. 1 of earnings.

High ratios may indicate overvaluation, while low ratios might suggest internal issues. Thus, investors shouldn't rely solely on P/E ratios but also consider other indicators like discounted cash flow and weighted average cost of capital for a more comprehensive analysis.

Limitations of P/E Ratio

• P/E ratio analysis offers a rough estimate of stock valuation but has limitations.

• It doesn't consider a company's EPS growth rate, leading investors to also use the PEG ratio.

• Earnings are released quarterly, while stock prices fluctuate daily, causing discrepancies in P/E ratios over time.

• Relying solely on P/E ratio for investment decisions can be misleading.

• Other crucial factors to consider include industry conditions, company history, market capitalization, EPS growth prospects, and industry demand.

What Is Price-To-Sales Ratio (P/S)?

The Price to Sales (P/S) ratio measures the company's value relative to its total revenue. Calculated by dividing share price by sales per share, it offers insight into how much investors are paying for the company. It's a straightforward way to gauge valuation, reflecting the core revenue-generating operations without accounting adjustments. Particularly useful for startups without net income, a low P/S ratio suggests undervaluation. However, historical and industry context is crucial. Comprehensive analysis considers all aspects of the company to uncover hidden issues beyond individual formula results.

Formula for the Price to Sales Ratio

 

 

The total sales value is sourced from the income statement, while the total number of shares outstanding is typically found in the income statement or its notes. Sales figures in the formula can stem from various time frames, such as the last twelve months, next twelve months, or trailing twelve months.

 

Similar to other financial metrics, the Price to Sales (P/S) ratio fluctuates daily, underscoring the need for a timestamped valuation. While the P/S ratio doesn't provide the actual valuation, it offers an expected valuation used to assess the true worth and compare it with other industry peers.

 

 

Example of P/S Ratio:

The table displays the share price and sales per share for a toy company, along with the calculated price to earnings ratio (P/E ratio). Over three years, the share price increased by 50%, outpacing the slower growth in sales per share. This indicates investors are now paying more for shares compared to three years ago.

Examining the P/S ratio reveals that in Year 1, investors paid Rs.1.25 per share, whereas in Year 3, they paid Rs 1.50 for the same share. Various factors, such as market trends, investor speculation, or the company's increased market share, can contribute to an uptick in the P/S ratio.

Limitations of the Price to Sales Ratio

• P/S ratio limitations stem from its variance across industries, making comparisons between sectors challenging.

• It fails to discern between leveraged and unleveraged companies, potentially masking financial risks.

• The ratio lacks insight into company profitability or costs, necessitating supplementary analysis with other financial metrics.

• Investors should avoid relying solely on the P/S ratio and instead consider it alongside other ratios for a comprehensive evaluation of a company's financial health.

Frequently Asked Questions

1. what is PE in stock market?

The PE ratio, or Price to Earnings Ratio, is a key stock valuation metric in the share market. It represents the ratio of a stock's share price to its earnings per share (EPS). This metric helps investors assess whether a stock is expensive or inexpensive at its current market price.

 

2. what is PS ratio?

The price-to-sales (P/S) ratio is a powerful tool for investors, offering insights into a company's stock price relative to its revenues. By comparing these two metrics, investors can identify potentially undervalued stocks with promising investment potential.

 

3. How can investors use the PE ratio in their investment strategy?

Investors can use the PE ratio to compare stocks within the same industry, assess growth potential, and identify potential investment opportunities.

 

4. Is a higher or lower PE ratio preferable?

It depends on various factors such as market conditions, industry trends, and individual investment goals. In general, investors seek a balance between growth potential and valuation when evaluating the PE ratio.

 

5. What is the difference between the P/S ratio and the P/E ratio?

The P/S ratio compares a company's stock price to its annual revenue (sales), while the P/E ratio compares the stock price to its annual earnings (profit).