PRICE/EARNINGS RATIO
The P/E ratio is an exceptional tool, because it is easy to calculate and also as it incorporates many valuation factors. This ratio comprises two components, one reflecting the expectation of market concerning future earnings (market price of shares) and another reflecting the earnings available to equity shareholders based on the results of most recent past accounting period. Sometimes this ratio, also called earning multiple, indicates how much an investor has paid for every rupee earned the company. The ratio is defining the relation between the market value per share and the earning per share:
For example, supposing the current market price is Rs.70 per share, and current period EPS is Rs.10 per share.
Price/Earnings Ratio = Rs.70/Rs.10 = 7 times
This implies that if Rs.70 is paid for these shares, then 7 years of earnings of Rs.10 per share are being bought. Since the current market value of a share reflects the expectations of investors concerning the future profits of the company, the ratio effectively measures the market's anticipation of future earnings.
Analysts generally compare P/E ratio with industry average and some other company within the industry. P/E ratios typically range between 5 and 30. High P/E ratios are associated with firms for which strong growth and good prospects is predicted in the future. If the P/E ratio of a firm is less than the industry average, we can say that the firm's share price is undervalued. The use of other firms in the industry as the control group is often not a solution because firms within the same industry can have different types of business, risk, and growth profiles.
Analysts and investors quickly use this ratio to decide whether the company is highly rated or lowly rated by comparing with P/E ratio of the market. Such comparisons should however be limited to within the industry and at a particular point of time.
Price Earning Ratio of Infosys Technologies Ltd. for the years 2006-07 and 2005-06 is given below:
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2006-07
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2005-06
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Market Price as on 31st March *(Rs.) (A)
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2,018
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2,981
|
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Earning Per Share (Rs.) (B)
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67.82
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88.67
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Price Earning Ratio (A) ¸ (B)
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29.76
|
33.62
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Infosys price earning ratio in 2006-07 was 29.76 as against 33.62 in 2005-06. Generally, P/E ratio of a firm depends on various factors, some of the important factors include earning growth, composition of debt and equity, brand etc. Infosys earnings have decreased during the year 2006-07 and there were no long-term liabilities. All these led to decrease in the earnings per share. The price to earning ratio of software scrips was 31.1 (Industry Analysis Report) and can be said that Infosys PE ratio was less when compared to industry average.
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