Price earnings ratio or PE ratio is one of the most important terms in equity investing. As the name suggests, it is the ratio of share price to earnings per share (EPS). In simple terms, it denotes how much you have to pay to buy Rupee 1 of EPS of a stock. A common use of PE ratio in investing is to see whether a stock is expensive or cheap. High PE ratio can imply that a stock is expensive, while low PE ratio can imply that a stock is cheap.
However, there can be other interpretations of PE ratios. High PE ratio implies that investors are ready to pay more to buy Rupee 1 of EPS and this is because they expect the earnings per share of the stock to grow faster in the future. Similarly low PE ratio can imply that investors do not expect the EPS to grow very fast.
Growth investors like to invest in stocks, which are expected to give high EPS growth and they are ready to pay more for such stocks. As a result, growth stocks have high PE ratios. Value investors, on the other hand, want to invest in stocks that are trading at low prices (lower than its fair value). Value stocks therefore, have low PE ratios. Investors should use PE ratios depending on their investment strategy (style).
