PE Ratio

PE ratio is one of the major ratio which is used to analyze the performance of a company.

It's formula is:

PE ratio= Stock price/ Earning per share

As we can see, the formula of PE ratio summarizes to the excess of stock price in comparison to the earning per share. For example if the price of stock is $100 and earning per share is $50, then the PE ratio is:

PE ratio= Stock price/ EPS = $100/$50 = 2

In analyzing shares, higher PE ratio can mean a company is performing good but it can also mean that the share is overpriced. An investor should analyze the market to understand the value of PE ratio which is good for investment.

Let us take some examples:

• As of the latest data (June 21, 2025), Alphabet Inc. (Google) trades at a trailing P/E of about 16.9×, based on a price of roughly $166.64 and an EPS of $9.15.
• The Trailing Price‑to‑Earnings ratio of Meta is currently about 27.2× as on 21/06/2025.

Analyzing these two stocks clearly shows that it is not necessary that higher PE ratio mean risky shares. It depends on the overall performance of the company.

 

Factors that affect PE ratio

1.     Earning performance of a company: If the earning of a company is high, the PE ratio is less and if the earning of a company is low, the PE ratio is high. Thus we should carefully evaluate the earning of a company while deciding to invest.

 

2.     The price of stocks: An increasing price of stocks increases the PE value and vice versa. This is because as the formula suggests, if the numerator value is higher, the overall value of the ratio is higher.

 

3.     Growth expectations: Companies which are expected to grow in the future have higher PE ratio. This is because the prices of such stocks increases in expectation that their future profits will increase.

 

4.     Risk and Volatility: Higher risky products have lower PE ratio because people are less willing to invest in such stocks.i.e they demand higher return for risk taken. This lowers price and as a result PE ratio decreases.

 

5.     Market Interest rates: If the market interest rate is high, the discounted EPS of a company lowers. This also affects the price of stocks. Thus the PE ratio is low. And if the market rate is lower, the discounted EPS is higher and as a result, the PE ratio is higher. Also the borrowing capacity of investors increase if the market interest rate is low. This increases price of stocks because of higher investing capacity and the PE ratio increases. The same is true for vice versa.

 

6.     Market sentiment and  Investor Behavior: If the market sentiment is bullish, the investor behavior is to increase investment in a stocks. Subsequently the price of stocks increase and thus the PE ratio increases. And if the sentiment in the market is bearish, the price of stocks decrease in anticipation of loses. Thus the PE ratio decreases.

 

7.     Company risk and stability: If the risk of a company is high or cyclical, it decreases PE ratio. This is because investor invest less in anticipation of loses. But in low risk and stable companies, investor estimate profits and the price of stocks is high. Thus the PE ratio is higher.

 

8.     Inflation and Economic conditions: If inflation is high, the purchasing power of investor lowers. As a result, the price of stocks lowers. Also in such economic conditions the profit of companies lowers. Thus PE ratio become lower. The vice versa is true for when the inflation is lower.

 

9.     Debt Levels: If a company operates in higher debt level, then it experiences lower earning per share. This is because the majority of income goes in payment of interest of debt. Thus the price of such stocks also lower because investor anticipate lower returns in terms of dividend and bonus share. Thus PE ratio becomes lower.

 But if the debt level is lower, the EPS becomes higher. The price of such stocks increases because investors can get higher return and thus the PE ratio increases.

 

10.  Dividend Policy: The companies which pay higher dividend may have lower P/E Ratios because they return cash to shareholders instead of reinvesting for growth. Thus their future profits decrease. Thus can also lower their share value. As a result the PE ratio becomes lower.

            But the companies which focus on growth and pay less dividend have higher PE ratios because                  they earn more by reinvesting. Thus the earning per share also increases as well as the price of                    stocks also increase.