Continuing our investment series after Market Capitalization let us discuss another Pertinent financial fundamental i.e Price Earning Ratio.
Formula of Price-Earning Ratio
Current market price divided by Earnings Per Share or Market Capitalization divided by Total Net Earnings.
It is one of the basic fundamentals to assess the company by Investors.
P/E ratio of 20-25 is considered good. P/E ratio of 20 means that an investor is ready to pay Rs.20 for Re.1 that the company earns.
However, a higher P/E Ratio suggests that the company may be overvalued and its stocks are overpriced thus making it risky for the investors to invest, while a lower P/E ratio suggests that the company may be undervalued as its current market price is less when compared to its earnings.
There are two types of P/E ratio
1. Forward P/E ratio
It is based on the future earnings of the organization. It is also known as the Estimated Price to Earnings Ratio. Earnings Per Share in this case are made on the estimated earnings of the organization.
2. Trailing P/E ratio
It is based on the historical earnings of the organization. It is more accurate and investors rely more on the actual figures than the estimated ones.
The best way to take investment decision based on the P/E ratio is by comparing the P/E ratio of related industries.
However, the P/E ratio should not be the only criteria for investing in the company various other fundaments like EPS, Current Ratio, Dividend Pay Out ratio should also be considered.
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