InvestorQ : As an investor in stocks, how do I use the P/E ratio and the Earnings yield ratio to take an investment decision?
swati Bakhda made post

As an investor in stocks, how do I use the P/E ratio and the Earnings yield ratio to take an investment decision?

Answer
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Dia Deshpande answered.
1 year ago


Price Earnings or P/E ratio is one of the most popular methods of gauging the relative valuation of a stock. For example a stock at a P/E of 10 needs to be looked at differently from a stock with a P/E of 25. Does that mean that a stock with P/E of 10 is undervalued and P/E of 25 is overvalued? Not exactly! P/E should always be looked at with respect to growth, margins and brand wealth. A company like Maruti may command a higher P/E just because it sustains growth momentum month-after-month. TCS may enjoy the highest P/E among large IT stocks due to the superior margins that it enjoys. Hindustan Unilever and Britannia may quote at fancy P/E ratios due to the strong brand value that they enjoy. Of course, at the index level, low P/E can be looked at as a sign of undervaluation and high P/E can be seen as a sign of overvaluation.

Another way to look at this ratio is to look at the reverse of the P/E ratio which is the earnings yield (E/P). It is what the share earns in terms of net profits. This can be compared to the yields on debt. If the earnings yield on equity is higher than the yield on debt, then it does make a case of equity undervaluation.