What is P/E Ratio? For a successful investment in the stock market, it is important to understand and make good use of several indicators. The Price Earnings Ratio (PER) is one of the most widely used indicators. It is the ratio of how high the price of a stock is relative to its earnings, which helps investors evaluate how much they are paying for a particular stock. In this article, we will learn more about what a PER is, how it is calculated, and how you can use it to invest.
What is P/E Ratio?
PER is calculated by dividing the stock price by the earnings per share (EPS). This indicator is useful for determining whether a stock price is actually overvalued or undervalued relative to the company’s earnings. Simply put, a higher PER means that the price of a stock is higher than that of a company, and a lower PER means that the price of a stock is lower than that of a company.
To calculate P/E Ratio
The formula for calculating PER is as follows.
[PER = Share price ÷ earnings per share (EPS)]
For example, what if a company’s share price is $100 and its EPS is $10? Yes, that’s right. This company has a PER of 10. This means that an investor would have to pay $10 to get a return on every dollar.
If you could interpret the meaning of P/E Ratio?
PER is basically expressed as a “multiple,” and the larger the number, the more the stock is valued for its earnings. Conversely, what if the PER is low? The stock is likely undervalued. However, judging everything from PER alone can pose risks.
For example, it should be noted that a start up with high growth potential may have a high PER due to low immediate returns, but this may be a reflection of future growth potential. On the contrary, in the case of mature companies whose growth has slowed, the PER may be low.
This may be because we do not believe that there is a great possibility of further growth in the market. Therefore, when analyzing and interpreting PER, it is correct to comprehensively consider the economic situation as well as the growth potential of the company and the characteristics of the industry.
Limitations of P/E Ratio Indicators
PER is actually a useful indicator, but it is unreasonable to use this indicator alone. For example, if the accounting standards are different between firms, the EPS calculation method may be different, so PER may be different. It should also be remembered that PER may not fully reflect future growth potential because it is based on the current profitability of a company. Therefore, when using PER indicators, it is recommended to analyze them with other financial indicators such as PBR and ROE. This can help you evaluate/analyze the value of a company more accurately and make the final investment decision.
Conclusion
PER is one of the essential indicators for us to invest in stocks and plays an important role in understanding the relationship between stock prices and corporate returns. If you make good use of PER, it can be very helpful in determining whether a stock is currently overvalued or undervalued. However, as explained in the limitations of indicators, it is important to analyze the PER indicator comprehensively with several other indicators rather than using it alone. This will help you make smarter investment decisions and achieve successful investment results. I’ll cheer you on. Thank you.
Also Read:
- Investopedia – Price to Earnings Ratio (P/E Ratio) Explained (Investopedia P/E Ratio Guide)
