Capital Structure Interview Question:

What is Price Earning Ratio (P/E Ratio)? How is it calculated? What is its significance?

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Price earnings ratio (P/E Ratio) is the ratio which is between the market price per equity and earning per share. High Price Ratio is used to give suggestion to the investors about their higher earning expected growth in future. It is usually used to compare the two P/E Ratio of different companies which are from the same industry. Investors should carefully note problems that arises with P/E Ratio measure to avoid biasing decision on many company's measure.

How is it calculated?

The P/E Ratio is calculated by dividing Market price per equity share to Earnings per share. This allows the company to estimate the appreciation in value of share of company and is used by investors for decision making on whether or not to buy shares in a particular company.
Following formula is used to calculate price earnings ratio:
“[Price Earnings Ratio = Market price per equity share / Earnings per share]”

For example:
The market price of share is Rs. 30 and earning per share is Rs. 5
Price Earning Ratio = 30/5 = Rs. 6

This shows that market value of every one Rs. of earning is Rs. 6. It is useful in calculation of financial forecasting and also helps in knowing whether or not the share of company are under or over valued.

What is its significance?

The significance of Price earning Ratio is it helps investor in deciding whether or not to buy the shares of particular company at a particular market price. Higher the P/E better is it for the company. If P/E ratio is low then the management should be more particular in knowing the cause of the fall as it can affect the company's position in the market.
Submitted by: Administrator