Can P/E Ratio Help You Choose the Right Stocks?

Even if you are a new investor in the stock market, you must have noticed something called P/E ratio mentioned in the analysis of any stock performance. At first sight, it may seem like a complicated financial term which only those involved in the field of finance may be able to understand, but in fact it is not so. P/E ratio simply stands for Price/Earnings ratio which is calculated by dividing the current share price by earnings per share in the last 12 months or even last few quarters. For example, the current price of a share is Rs 300 and its earnings per share in the last 12 months is Rs 10, then the P/E ratio for that share would be 300/10 = 30.

This is a financial ratio which is simple enough to calculate, yet for stock traders it holds great value in estimating the worth of a share based on objective criteria. It gives an approximation of a shares’ worth and a higher P/E ratio usually shows a company which is growing at a good pace and investors have high expectations of rise in future earnings of the company. On the other hand, a higher P/E ratio can also denote an over-valued stock with people expecting more future growth. If these expectations are not realized later in the form of growth, P/E ratio can come down drastically, thus reducing the worth of a stock by the same degree.

Usually, for an online stock trader not ready to take large risks, the shares of a company with relatively low P/E ratio but strong fundamentals would be a good choice. It essentially indicates that although a company has the desired potential to perform well in future, the market has not yet realized its worth and hence its stock is currently undervalued. However, one must not solely rely on P/E ratio while trading in Indian stock market as there are a number of factors to be considered before making an informed decision for investment.