Don't Waste Your Time On PE: Focus On The Business Instead

Unveiling the PE Ratio-Return relationship: Insights from our research

Currently, the market’s PE ratio might appear elevated when viewed in isolation. However, when considering other critical parameters like the earnings’ cycle, price-to-book value, market capitalisation to gross domestic product (GDP) ratio, and more, the landscape differs from the previous market peaks. Taking all this into account, Bhavya Rathod highlights the fact that the PE ratio alone is not enough to drive investments 

As we witness another phase of correction following the recent highs, the age-old discourse surrounding valuation re-emerges. However, before you contemplate altering your investment allocation in response to whether the market appears overvalued or undervalued, it’s crucial to grasp precisely which valuation metrics merit your attention. One such metric that can provide valuable insights into this intricate puzzle is the price-earnings (PE) ratio. The PE ratio is a financial metric that boils down to a simple equation: It takes the current market price of a stock, which represents what you are willing to invest to acquire it, and divides it by the earnings per share (EPS), which denotes your earnings for each share you hold. 

Essentially, the PE ratio serves as a measure of the price you are prepared to pay for a company’s annual earnings. For instance, if a stock boasts a PE ratio of 20 times, this signifies that for every unit of your currency (as for example, ₹ 1), you are willing to allocate ₹ 20. However, it’s crucial to note that this price doesn’t solely reflect the actual earnings. Rather, it conveys your anticipation of the company’s annual earnings growth. A high PE ratio indicates heightened expectations of robust earnings growth in the upcoming year, while a lower PE suggests a more conservative outlook in this regard. Furthermore, as an investor, it’s essential to acquaint yourself with two key variations of the PE ratio: trailing PE and forward PE.