In your interest.
Online Personal Finance Magazine
No beating about the bush.
If there is one number that the whole world looks at closely while evaluating stocks and the overall market, it is the Price to Earning Ratio (P/E). P/E is the prism to judge whether stock price is high or low. If the market P/E is around 20, it is supposed to be expensive and if it’s 12, it is supposed to be cheap. But how reliable is this ratio for predicting future returns?
P/E measures the number of times a stock quotes as a multiple of its earnings per share and is also commonly referred to as the P/E multiple. It is simply the number of times the market is willing to pay for one rupee of the company’s earnings. A high P/E signifies high expectations of investors from the company. Investors have already caught on to the company’s earnings growth story and today’s prices reflect that. A low P/E signifies that investors have low expecta-tions from the stock. Since the market acts to fool the largest number of people the maximum number of times, a high P/E stock is supposed to lead to disappointment. The logic is that since a high P/E already incorporates investors’ expectations and the stock has already been bought by a larger number of investors during its run up, there are fewer investors left to buy and even a slight disappointment can send it skidding.
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