What is P/E Ratio | Price Earning Ratio and How is it Calculated ? | ETMONEY

The price-to-earnings ratio or the P/E ratio is one of the most widely used metrics by investors and analysts to determine a company's valuation in the stock markets. In this video, ETMONEY’s Shankar Nath explains the concept of PE Ratio and how everyday investors can use the PE Ratio to improve their portfolio returns & manage risk better.

Topics covered in this video:
00:00 Introduction
01:16 What is the PE ratio?
02:38 PE ratio as a valuation tool
07:38 Predicting Stock Market Returns
11:10 Improve your Investing Strategy with P/E Ratio

👉 What is PE Ratio?

The Price-to-Earning Ratio or the PE Ratio is a method of valuing a business on the basis of the current profits earned. For example - if a stock is available at ₹10 and currently earns ₹2 in profits, then the P/E Ratio of the stock is 5.

👉Importance of PE Ratio in Investing

The PE Ratio gives a sense of direction and acts as a thumb rule on how much should be paid for investing in a stock, sector or index. The video goes deeper into the Nifty 50 (index) and the Nifty Pharma Index (sector index) in establishing how the price earning ratio can act as a guiding beacon on improving investment decisions and reducing downside risk. Specific time periods such as the 2011 to 2013 period (for Nifty 50 index) and 2018 onwards period (for Nifty Pharma) have been taken to illustrate this point.

👉 PE Ratio and Stock Market Returns

This is a particularly important section where explain the relationship between PE ratio and Stock Market Returns. This is a data-rich section and we use the example of the Nifty 50 to understand the expected stock market performance returns when one invests in this index at a lower or higher price earning ratio for a period of 1 year, 3 years, 5 years, 7 years, 10 years, 15 years and even 20 years.

This ETMONEY analysis clearly shows that investing in months where the PE ratio is at the lower end can be hugely profitable in the short term. And while investing at a higher PE ratio may not be a good idea for the short term, the impact of this gets reduced dramatically over the long run. Infact for long term goals, a high price earnings ratio doesn’t impact your returns much and there is less variability in your returns. In other words, time removes any fears of investing in an overvalued market or dissipates the happiness of having invested in an undervalued one

👉 PE Ratios and Mutual Fund Investing

► Strategy 1 : Investing in Index Funds
Index funds mimic the stock markets and hence they represent the stock market’s state of overvaluation or undervaluation. So if the PE ratio of an index like the Nifty 50 goes down, there is enough data to suggest that the price earning ratio will revert back to its long term mean of 20 eventually. Periods of undervaluation (below 20) becomes a great time to invest.

► Strategy 2 : Investment in Thematic Funds (or Sectoral Funds)
Thematic or sector funds are generally more volatile than broader schemes. This represents The PE ratio at which you invest has a bearing on your portfolio risk and portfolio return.

This means if you invest in such a fund when the PE ratios are low then the chances of you making high returns on your investments increase and the chances of you making negative returns decrease in a similar proportion.

► Strategy 3 : Balanced Advantage Fund and Asset Allocation
The balanced advantage fund is designed to rejig the composition of equity and debt in the scheme on the basis of current market conditions and expectations of the future.

This automatic play by Balanced Advantage Funds is mostly based on the PE ratio model and helps investors manage stock market variability better and get above-average returns at below-average risk

👉 Resources:
► Rich Dad Poor Dad : https://amzn.to/3pJkVL1

#PriceEarningRatio #PERatio #NiftyPERatio #ETMONEY

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