Why is the P/E Ratio important?

A good understanding of PE Ratio gives the investors an idea if the stock has sufficient growth potential. The P/E ratio is one of the most widely used stock analysis tool by investor before making taking an investment decision.

But P/E ratio varies from industry to industry. There are sectors like diamond, fertilizers etc that have a low P/E ratio and there are other sectors like Pharma, IT that command high P/E ratio. It is important to have a good understanding of both.

1. HIGH P/E: A high PE ratio implies that market participants are bullish on the stock and expect the company to post higher earnings growth going forward. However, it can also be interpreted as an overpriced stock in some cases.

2. LOW P/E: Most attractive investment opportunities are shown by companies with low P/E ratios. It is not always true. Low P/E ratios reflect that Companies with high current earnings but dim future prospects. A company having a low PE ratio can be considered good bargains as their growth potential is still unknown to the market.

The P/E ratio of different sectors varies that is why it is important that the P/E ratio of one company should be compared with the companies in the similar business sector.

Browse more