In share market PE ratio now a day get so much popularity as
an indicator of the movement of market in long term prospects. Many have an opinion
that when PE Ratio is 25 and above, it indicate market is overpriced and when
PE Ration is 15 and below it is under priced. So based upon it investor should
enter into market when PE Ratio is below 15 and should exit from market when PE
Ratio is above 25. So now the question is whether this theory is correct ?
Now to get the answer of this question I will tell you the
concept of PE Ratio and will also show you some practical scenario.
What is PE ratio : there
is 3 concept which come into picture of PE Ratio
1)
Earning per share
2)
Price you want to pay to get that earning per
share
3)
Ratio of the above
Formula of PE Ratio
and concept: PE Ratio = Price per
share/Earning per share
So we can say in case of PE Ratio = 10, to get an earning of
Rs. 1 we are ready to pay Rs 10 as price or to get an earning of Rs 2.5 we are
ready to pay Rs. 25
So PE Ratio in above case is Price/earning 10/1=10 or 25/2.5=10
ROI in share market: an
investor in share market expect to get 2 type of return on his investment
1)
Risk free Return
2)
Risk Premium
Risk free return is nothing but return on FD or Return on
Bond etc.
Risk premium is the rate of return investor want to get on
behalf of risk taken by him by investing his capital in share market
Now risk free return changes with the changes in rate of
return of FD, Bond etc but rate of risk premium changes with the risk in
market. So we can say when risk in market is high investor will expected to
received higher risk premium and vice versa.
Below I share you details of 2008 when we will analyse the
whole concept of PE Ratio and also will also decide when it can be an indicator
for investor to enter or exit from share market.
|
Date |
P/E |
Market
close |
Eps |
|
|
1-Jan-08 |
27.64 |
6,144.35 |
222.3 |
|
|
1-Feb-08 |
22.68 |
5,317.25 |
234.4 |
|
|
3-Mar-08 |
21.12 |
4,953.00 |
234.5 |
|
|
1-Apr-08 |
20.66 |
4,739.55 |
229.4 |
|
|
2-May-08 |
22.42 |
5,228.20 |
233.2 |
|
|
2-Jun-08 |
20.17 |
4,739.60 |
235 |
|
|
1-Jul-08 |
16.66 |
3,896.75 |
233.9 |
|
1-Aug-08 |
18.56 |
4,413.55 |
237.8 |
|
1-Sep-08 |
18.38 |
4,348.65 |
236.6 |
|
1-Oct-08 |
16.98 |
3,950.75 |
232.7 |
|
3-Nov-08 |
13.33 |
3,043.85 |
228.3 |
|
1-Dec-08 |
11.76 |
2,682.90 |
228.1 |
I have given data of first trading day of each month of the
year 2008. In case of any reader require data of each day then he/she can
download it from www.nseindia.com
From the data of 2008 we can observe that EPS of nifty did
not get reduced but share market on that time get reduced from 6144 to 2682 and
PE Ratio from 27.64 to 11.76. I am expecting that all my reader know about the
fall of share market in 2008.
Analysis of PE Ratio:
we can observe from above data that EPS is not reducing but PE Ratio is
reduced sharply because at that time the risk in the market was very high and
as we know when there is high risk investor will look for high return.
Now we are going to understand the relationship between ROI
and PE Ratio. Suppose in normal situation you pay Rs 25 to get an earnings of
Rs 2.5 and here ROI will be 10%. Now suppose because of any pandemic there is
high risk in the share market to lose your investment so in this situation you
want higher ROI (suppose 25%). Since EPS is same as we can see in above data
then to get higher ROI (25%) we must pay lesser price and that will be Rs 10.
So we can say that to get 25% of ROI at EPS of Rs 2.5 we have to invest only Rs
10. And here new PE Ratio will be 10/2.5=4
So we can say that PE Ratio has been reduced from 10 to 4
Conclusion: so as
per my opinion PE Ratio is not an indicator for the investor to enter or exit
from the market but it is response of the market.
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