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Price-earning (P/E) ratio is commonly used while taking investment decisions by many investors. P/E ratio is the ratio between the market price and earnings per share. The ratio indicates the market price of a share vis-a-vis its earnings.

According to one view, lower the P/E ratio, the better it is for investors, as there are chances of higher appreciation.

According to others, it is the other way round. Of course, there are exceptions to these theories as well. P/E ratio is calculated as market value of each share divided by its earnings. For example, if a company's stock price is Rs 200 and it has an earnings per share of Rs 5, the PE ratio is Rs 40 ( Rs 200 divided by Rs 5).

The earnings per share can be taken for the full year or for the last few quarters. It can also be taken from estimates of earnings expected in the next few quarters.

Sometimes, the P/E ratio is referred to as the 'multiple', because it shows how much investors are willing to pay per rupee of earnings. In general, a high P/E means high projected earnings in the future. However, a P/E ratio actually doesn't tell you a whole lot by itself. It's usually only useful while you compare companies in the same industry, or a company's own historical P/Es.

The higher the P/E, the more you are paying for an estimated stream of earnings. Investors usually are willing to pay a higher P/E for companies they judge will be growing faster than the norm even though they do not pay those earnings out in dividends but retain them to fund future growth.

If that growth is realised, the price of the company's stock usually grows faster than the price of a company with a slower growth or higher dividend-paying company. So, the higher P/E produces greater upside potential.

However, if the estimated earnings are not realised or the stock itself loses favour with investors, the downside potential is greater as well. The risk is not just in the ability of the company to earn profits, but also in the higher price you pay relative to its earnings. If a company goes from a P/E of 50 to a P/E of 25 and maintains earnings of Rs 5 a share, your investment goes from a value of Rs 250 per share to a value of Rs 125 per share even though the company is still earning profits.

P/E ratio is a commonlyused way to value a company and to determine what a company's stock should be worth. Generally, a company with a high P/E ratio is expensive when compared with a company with a low P/E ratio, since with a high P/E ratio one is paying a larger multiple against a company's earnings.

igher P/E ratios are often associated with 'growth stocks', or companies that are growing faster than average. Investors believe that such a company's earnings will be higher in future. Usually, this yardstick is used to analyse whether a stock is under-valued, overvalued or trading at fair value by investors planning to buy stocks. 

SOURCE :- ET