You will often see "P/E" in market news. It stands for price-to-earnings ratio. It is a quick way to compare a company's share price with the profit it makes.
Step 1: earnings per share (EPS)
First, divide the company's yearly profit by its number of shares. Say our made-up Sunrise Biscuits Ltd made a profit of ₹100 crore last year and has 10 crore shares. Its earnings per share (EPS) is ₹100 crore ÷ 10 crore = ₹10.
Step 2: the P/E ratio
Now divide the share price by the EPS. If Sunrise Biscuits' share is at ₹200, its P/E is ₹200 ÷ ₹10 = 20. In simple words: people are paying ₹20 for every ₹1 of yearly profit.
Why P/E needs context
It's tempting to think a low P/E means "cheap" and a high P/E means "expensive". It's not that simple:
- A high P/E can mean people expect profits to grow fast. Those expectations may or may not come true.
- A low P/E can mean people expect profits to fall, or that the company has problems the number doesn't show.
- Different industries usually have very different P/E levels, so comparing a bank with a software company doesn't tell you much.
- Profits can jump or drop for one-off reasons, like selling a building, which makes the P/E look odd for a year.
- If a company makes a loss, the P/E doesn't mean anything.
You might also see "trailing P/E" (using last year's actual profit) and "forward P/E" (using someone's estimate of next year's profit). Forward P/E depends on a guess, so treat it with extra care.
How to use it
P/E is a starting point for questions, not an answer. It can help you understand why people are talking about a company, but it doesn't tell you whether its share is worth buying. No single number can.