What is PE Ratio? How it is useful for an Investor?

As we get closer to creating the PE ratio formula, we now ask for your undivided attention for the next two to three minutes. Assuming, of course, that the firm’s earnings remain constant, the PE ratio may be thought of as the number of years it will take the company to earn back the amount of your initial investment. Let’s imagine you paid Rs. 4,000 to purchase 100 shares of ABC Ltd. Given the current profits per share of Rs. 4, your 100 shares will yield Rs. 400 in a year, and your initial Rs. 4,000 investment will be recovered in 10 years.

The PE ratio of every firm can be found on Google, so you don’t have to go through this laborious calculation. Simply prefix the firm name with “price to earning” or “pe ratio.”

Purchasing stock in a firm with a price to earnings ratio of two will allow you to recoup your initial investment in two years, but purchasing stock in a company with a pe ratio of 40 will need you to wait forty years to do the same.

Any firm that is reasonably valued will have a PE ratio that is equal to its growth rate. Here, we’re referring to the growth rate of earnings. The growth rate and PE ratio can also be compared. If it’s PE is 16, you would anticipate that ITC will increase at a rate of around 16% yearly, etc. However, you could have found a good offer if the PE ratio is lower than the growth rate. According to us, a purchase with a PE ratio of 6-7 and business growth of 16 is quite appealing. On the other hand, a PE ratio of 16 is not a wise investment if the growth rate is 6-7 percent yearly. A PE ratio that is half the pace of growth is extremely favorable, while one that is double the rate of growth is quite unfavorable. When examining equities for investment prospects, we frequently utilize this metric.