Price / Earning Ratio

Price/Earning Ratio

The Price/Earning (P/E) Ratio is a profitability ratio that connects the market's perception of a company's shares with its actual earnings performance. It tells you how much investors are willing to pay for each rupee of a company's earnings.

Formula

P/E Ratio = Market Price of a Share / Earnings Per Share (EPS)

Example from the textbook: If EPS of X Ltd. is ₹10 and the market price is ₹100, the P/E Ratio is 100/10 = 10 times.

What It Tells You

The P/E Ratio reflects investors' expectations about the growth in the firm's earnings and the reasonableness of the market price of its shares. A high P/E Ratio generally means investors expect higher earnings growth in the future. A low P/E Ratio may indicate that the market perceives the company's growth prospects as limited, or that the share is undervalued.

Important Distinctions

P/E Ratios vary from industry to industry and from company to company within the same industry. This variation depends entirely on investors' perception of the future of each company. You cannot compare the P/E Ratio of a company in one industry with that of a company in a different industry and draw a meaningful conclusion.

The textbook's worked examples for this topic now live in this chapter's Illustrations & practice tab, alongside their full solutions.

Accounting Treatment Note

The P/E Ratio is a market-based ratio. It does not involve any journal entry or debit/credit treatment in the books of accounts. It is purely a tool for analysis and interpretation of financial statements.

Key Points to Remember

• P/E Ratio is always expressed as "times" (e.g., 9.86 times), not as a percentage.
• The numerator is the market price of one equity share.
• The denominator is the Earnings Per Share (EPS), which itself requires calculating profit available to equity shareholders.
• Preference dividend must be deducted from net profit after tax before calculating EPS. …