What is it?
A price-earnings (P-E) multiple is the valuation of each rupee of profit made by a company through the stock market. It is a valuation ratio of a company’s current share price compared with its per share earnings. A P-E multiple of four would mean that each rupee of profit is valued at Rs4, or that you will pay Rs4 for each rupee of profit the company earns.
How to calculate it?
P-E is calculated by dividing the share’s market price by the earnings per share (EPS). EPS is a company’s net profit divided by the number of outstanding shares. If the EPS is Rs10 and the price Rs100, the P-E multiple would be 10.
How to assess it?
A P-E multiple indicates a firm’s growth prospects. Firms on a growth path generally have a high P-E multiple. A high multiple, in such cases, doesn’t necessarily mean that a stock is expensive. Companies with a good track record and steady dividend payments also enjoy relatively high P-E multiples. Companies that have weak growth prospects or have a product suite that is considered a “commodity”, typically, have low P-E multiples.
Watch out for
This figure can’t be manipulated directly. But some companies may inflate their profit figures, leading to a high EPS, which, in turn, would mean a low P-E, making the shares look attractive. This figure is important, but before buying a stock you must look at factors such as the business model, the management and other fundamental indicators.