Reblog: How to use the P/E ratio
Valuations are looked at through the prism of cash flows, earnings, corporate governance, return ratios, debt-equity proportion and so on. Within these, the most primary valuation tool used by investors is the Price Earnings (P/E) ratio.
The P/E ratio is arrived at by dividing the stock market price with the company’s Earning Per Share (EPS). For example, a Rs 200 share price divided by EPS of Rs 20 represents a PE ratio of 10. Theoretically, it translated into the assumption that if we were to buy this company today it would take 10 years to earn back our investment.
The Trailing P/E ratio uses the earnings of the last 12 months, while the Forward P/E uses the expected earnings for the next 12 months, which means it requires estimating the forward earnings.
At Mumbai’s Morningstar Investment Conference in October, equity market strategist Ridham Desai and head of Morgan Stanley’s Indian equity research team tackled the subject of India’s high P/E.