Price to earnings (P/e) ratio and it’s value for valuation of company

To search an undervalued company is a dream of every investor but it will not happen only by wish rather it requires deep analysis of company earnings to find the undervalued or overvalued company. P/e ratio is one of the financial ratios which helps an analyst to determine the value of a company.

The P/e ratio is an appealing ratio due to t it’s an easiness to understand in relative to other ratios and can be identified by dividing the current market price of a share to earning per share (EPS) of a company.

                                    P/e ratio = Share price

Being an easy process to identify the P/e ratio cannot solve the theory to find the value of a company until it cannot compare with different category of P/e ratio. Based on my knowledge, I utilised three P/e ratio comparison to find the undervalued company. These are:-

1. Company to Company P/e ratio comparison – It cannot be ignored as you cannot find the popularity of shop until you cannot compare it with the neighbour shop of the same category product line. The P/e comparison of two companies is also helping to get the popularity or value of company among the two. A company with lower P/e has a higher potential to gain profits shortly. For eg:- there are two companies denoted by A and B with similar types of products. Company A’s current market price is 100 and EPS is 50 then P/e of company A is 2 (100/ 50 ).

Company B’s current market price is 100 and EPS is 20 then P/e of company B is 5 (100/20).
It is clear from this example that P/e of Company A < P/e of company B which means Company A has more potential to rise in future in comparison to Company B.

2. Company to Industry P/e ratio comparison – If you go for a shopping to six shops to buy cloth of same quality and find that out of six, five are selling cloth of same quality at the same price and the sixth one is selling at a lower price. What would you like to do? Of course, you ill buy from the sixth shop. Industry P/e ratio is also telling the average price to earnings ratio of various companies in a particular segment and f yu find any company’s P/e ratio is lesser than the industry P/e then it will help to get the better results in a long run. One thing, we need to take care that there should no compromise with the fundamentals of a company while selecting based on lower P/e ratio. 

3. Company’s Current P/e ratio to Company’s Historical P/e ratio comparison – The historical P/e is the average P/e of a company for the defined time frame. If the selected company’s current P/e is less than the historical P/e of the defined period then it’s a good deal to buy the company share.

P/e plays an important role in finding the undervalued company but it works best when combined with other ratio analysis.

I hope the above topic is helpful to find the undervalued company

If you have any questions, please feel free to write in the comment section.


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