For an investor to invest should the PE ratio be high is the money question.
PE = Market price per share
Earning per share
PE ratio is derived by using the above formula and EPS could be derived using the formula expanded below.
Earnings per share = Earnings attributable to share holders
No: of Shares
Having a higher PE ratio is definitely is a strength of the company. Because it shows the confidence the investors has placed on the shares of the company.
lets take an example to further understand the anomaly of PE ratio.
company A has a PE ratio of 16, and the earnings per share is Rs. 5, company B has a PE ratio of 5 and the earnings per share is Rs. 5.
Based on the figures the market prices of the two shares can be derived as,
A = 16*5 = 80
B = 5*5 = 25
See an investor is paying Rs. 80 for a company which is making rs. 5 earnings per share, where as he could have invested in a company with similar earnings for an amount of Rs.25.
If an investor seeks speculation definitely he would opt for company A, because in a booming share market investors tend to invest on shares with high PE ratio. But in the long run put your money on the company with lower PE ratio. When the industry PE ratio is improving there is higher probability that the market price would improve.
