PE Meaning: Price to Earning Ratio

PE is a popular valuation ratio which is used to determine whether a stock is cheap or expensive. The full form of PE is Price to Earning.

On newspapers and business channels, PE is also sometimes called ‘earning multiple’, ‘price multiple’ or simply as ‘multiple’.

The formula to get PE ratio is:

PE = Share price / EPS (Earnings per share)

For example, if the current market price of ‘Reliance Industries’ is ₹ 1000 per share and the earnings per share over the last 12 months is 50, then the PE ratio is 1000 divided by 50 = 20.

Important points:

Quality companies almost always command a higher PE ratio.
Companies that are expected to show high earnings growth in the future are valued higher, hence they could have a higher PE ratio.
Some sectors could have higher PE ratio than others. For example, currently FMCG companies companies command significantly higher PE as compared to IT companies.
Low PE does not necessarily mean the stock is cheap, there is always a reason why the market gives lower PE to some companies. It could be because of management issues, lower growth or some other reason.

Trailing PE vs Forward PE

There are two ways to calculate PE ratio:

Trailing PE: The earnings per share of the last 12 months is used to calculate the PE ratio.
Forward PE: The ‘estimated’ earnings per share in the next 12 months is used to calculate the PE ratio.

Trailing PE is displayed on financial websites like Moneycontrol. Whereas Forward PE is analysed in research reports, where the analyst forecasts the future earnings of a company.

Since it is based on assumptions for the future, Forward PE can vary depending on the expectations that an analysts has from a company. If a company performs better than expectations, the stock price could rise.