The Magic of P/E Ratio

The P/E Ratio is an indicator of the Value of a security. The numerator- MARKET PRICE is the value submission of the interaction of demand and supply of the security in an exchange, while the denominator is the Companies Earnings derived from the books of the company. Here is why we call it magical:

  • Just like you use a simple Payback period to evaluate a long-term project for its Project appraisal and viability, the P/E ratio is a quick test of the entry/exit price of a quoted security.
  • The closer the market price of a stock is to its traded market price, the more attractive it is (holding all other factors constant. The Farther the market price is to the earnings, it becomes an expensive stock and Investor at this point must exercise cautious optimism (especially at entry Point)
  • The P/E ratio is the 1st analytical fundamental tool to shortlisting securities that will go into a portfolio. It is a screening ratio.

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