# Price Earning (PE) Ratio

Price Earning Ratio is a type of Profitability Ratio that determines the Market Price of share relative to its Earning Per Share. It is a measure to check how well equity is priced in a market.
$$Price\quad Earnings\quad Ratio=$$$$\frac { Market\quad price\quad Per\quad Share }{ Earning\quad Per\quad Share }$$ Market Price Per Share is the price at which common equity is trading in the market. Where,
And $$Earning\quad Per\quad Share=$$$$\frac { Net\quad Profit }{ Total\quad Number\quad of\quad Common\quad Equity }$$

## Significance and Interpretation

• PE ratio helps investors to determine the pricing standard of equities in the market, a higher PE indicates that a share is highly-priced with respect to its EPS.
• Investors are attracted by the lower PE ratio of stock as it assures that the equity is priced correctly with respect to its EPS.

### Examples

#### Example 1:

Given below are few details of M/S XYZ Ltd. and ABC Ltd., use them an calculate the PE Ratio for M/S XYZ Ltd and ABC Ltd. and decide which investment is better.
Particulars (XYZ Ltd.) Amount (in Rs.) (ABC Ltd.) Amount (in Rs.)
Equity Share Capital @ Rs 10.00 each 5000000.00 5500000.00
Market Price Per Share 40.00 10.00
EBIT (Earnings Before Interest and Taxes) 4000000.00 2500000.00
Interest Expenses 1000000.00 800000.00
Tax Payable 500000.00 300000.00

#### 1. XYZ Ltd.

Net Profit = EBIT – Interest Expenses – Tax payable
Rs. 2500000
Total Number of Common Equity = 5000000 / 10
500000
EPS = Net Profit / Total Number of Common Equity
2500000 / 500000
Rs. 5
PE Ratio = Market price Per Share / EPS
40/5
8
Hence, Market Price per Share of XYZ Ltd. is 8 times the annual earning of the share.

#### 2. ABC Ltd.

Net Profit = EBIT – Interest Expenses – Tax payable
Rs. 1400000
Total Number of Common Equity = 5500000 / 10
550000
EPS = Net Profit / Total Number of Common Equity
1400000 / 550000
Rs. 2.54
PE Ratio = Market price Per Share / EPS
10/2.54
3.94
Hence, Market Price per Share of ABC Ltd. is 3.94 times the annual earning of the share.
By comparing the PE Ratio for both the companies, it can be concluded that Shares of ABC Ltd. are more correctly priced as compared to shares of XYZ Ltd. 