How it works
The price-to-earnings ratio (P/E) compares a company's share price with its profit per share. It tells you how many rupees investors are paying for each rupee of the company's yearly earnings.
Earnings per share (EPS) = net profit ÷ number of shares
P/E = share price ÷ EPS
Equivalently: P/E = market capitalisation ÷ net profit
The earnings yield turns the P/E upside down: EPS ÷ price. A P/E of 20 is an earnings yield of 5%, which is handy for comparing with interest rates.
Worked example
Worked example: A made-up company
Narmada Paints Ltd (a made-up company) earned a net profit of ₹600 crore over the last 12 months and has 25 crore shares. Its share price is ₹480.
| EPS: ₹600 crore ÷ 25 crore shares | ₹24 |
|---|---|
| P/E: ₹480 ÷ ₹24 | 20 |
| Earnings yield: ₹24 ÷ ₹480 | 5% |
| Market capitalisation: ₹480 × 25 crore | ₹12,000 crore |
Investors are paying ₹20 for every ₹1 of yearly profit. Whether that is expensive depends on how fast the profit is likely to grow, how reliable it is, and what similar companies trade at.
How to read the result
- A higher P/E means investors are paying more for each rupee of current profit, usually because they expect faster growth or more reliable earnings.
- A lower P/E can mean the shares are cheap, or that investors expect profits to shrink, or that the business is risky.
- Compare like with like. P/E is most useful against the company's own history and against similar companies in the same industry. See why sectors are valued differently.
Limitations
- Losses make the P/E meaningless. If earnings are zero or negative, there is no useful P/E; the calculator says so.
- One-off items distort it. A big one-time gain inflates profit and makes the P/E look low.
- It ignores debt. Two companies with the same P/E can have very different debts. EV/EBITDA takes debt into account.
- No P/E is "good" or "bad" by itself. Treat it as the start of a question, not an answer.