Today we will explain to you the concept of Price to Earnings or as it is famously called PE ratio. Now the name itself gives a lot of clarity as to what it means.
Let us show you an example. Suppose there is a company called Finsense Gurukul (Good for us, we actually exist :P ) and it is owned by 2 people having 50 shares each (Total 100 Shares).
Now Finsense Gurukul in this year earns a profit of Rs 100 in total. This profit of Rs 100 will be divided equally into 100 parts (because there are a total of 100 shares).
Each share will be entitled to Rs 1 of profit (Rs 100 divided by 100 shares total); this is called Earnings per share. Now suppose these shares which are earning Rs 1 per share (EPS) are being sold at Rs 5 in the market.
Now Rs 5 is being paid for a share that is earning Rs 1, so applying basic mathematics, we are paying 5 times the share earnings (How? Rs 5 being paid divided by Rs 1 earning behind each share). This is nothing but the price to earnings ratio or PE in short. Simple isn’t it?
