P/E Ratio

This expression combines two important company variables. This establishes a relationship between stock price and earning for the past twelve months. This ratio is normalized value for per unit earning. In other words, it tells us, for every dollar earned, how much the market is paying for one of its shares. Therefore, if one is considering investing in a company, an examination of its historical P/E values would readily indicate if the current price is more or less than what others have paid for the shares of the said company in the past. P/E also reflects investor perception of the future earning potential. During periods of economic boom, general P/E ratios tend to be high. And the reverse is true when economy does poorly. Fast growers tend to have high P/E ratios as compared to mature companies which tend to grow at slower rate. While looking at multiples, it is good to keep things in perspective. There is no hard and fast rule that says that a particular company ought to have a certain multiple. If there is, then is it two, five, twelve or what? Here, I have not seen any compelling argument to convince me with a number. Therefore, I think it is a good idea to compare a specific P/E ratio with industry standard. If the number is too high, then it would be safer to touch the face of a Royal Bengal tiger than to invest in it. The stock price is bound to come down sooner or later. P/E ratio can also be viewed as number of years a company will take in earning an initial investment, assuming that it will maintain the current rate of earning. Stock price (P) is very strongly influenced by fluctuations in earning (E). One does not change without changing the other. I would consider it a great investment opportunity, if I came across a company having a low P/E multiple while its earning-growth is red hot. Sooner or later, its P/E is bound to catch up. One can say that a company is fairly priced if P/E is more or less equal to its rate of earning growth. If the P/E is less than the growth rate of earning, it is a bargain!