9.10 P/E ratio (Price-earnings ratio)

Ratio Analysis

This is obtained as follows

Market Price Of The Share----------------------------------------------
EPS

For instance, as on October 20, 2003, the market price of TISCO was Rs 346.80. Its P/E ratio on that day was 346.80/27.51 = Rs 12.60.

Relevance Of PE Ratio:

This is the most important ratio for guessing the price of a share. The P/E ratio indicates the number of times the price of a share is more than its EPS. A company having a P/E ratio of eight has its price eight times over its EPS.

Which factors influence the P/E ratio?

The P/E ratio is a derivative of all stock-specific and market- specific factors that influence the price. For instance,

1. P/E ratio of a company remains very high when the company has maintained sound financial health over the years.
2. P/E ratio remains high when the management has consistently shown a good record. It does not go up if the investors do not trust the management. For instance, all Tata companies have high P/E ratios.
3. If a company is a market leader having strong manufacturing, marketing and financial operations and has sound future plans, its P/E remains high. Blue chips like ITC, HLL, etc fall into this category.
4. P/E ratio of any growth-oriented company is very high. A company like Divi’s Laboratories, which has grown substantially in the last few years, understandably has a high P/E ratio.
5. When investors have high expectations about the future potential of some industry, the P/E ratios of all companies in that industry go up. Poor expectation about any industry results in a fall of the P/E ratios of all companies belonging to that industry. For instance, the average P/E ratio for the cement companies soared to 35 in July 1991, while the average P/E ratio of electronics’ companies languished at 17.6.
6. P/E ratios of all companies go up during the bullish market and fall during the bearish phase.