PE multiple or Price-to-Earnings multiple (also called PE ratio) is one of the important measures to understand valuation of stocks. It denotes whether a rise or fall in share price is justified by earnings prospects of the company. Simply put, the multiple tells investors what is the price to be paid per share for one rupee of earning generated by the company.
The formula to calculate PE multiple is as under:
PE multiple = Current Market Price / Earnings Per Share (EPS) of the year
E.g. If the share price is Rs. 100 and company’s EPS for the year is Rs. 20, its PE multiple is 5 times.
The Earnings Per Share (EPS) can be based on historic earnings (for the previous completed fiscal year), trailing (most recent) 12 months or forward earnings (expected EPS one year hence).
A higher PE multiple means that investors are paying more for each unit of income, indicating that the stock is more expensive compared to one with a lower PE multiple, all other parameters being equal.
Thus, stocks with are expected to have higher earnings growth will usually have a higher PE ratio compared to those that are expected to have lower earnings growth, which will have a lower PE multiple. Likewise, industries / sectors which are fast growing enjoy a higher PE multiple.
It is usually not enough to look at the PE multiple of one company and determine its status. It is used more as a comparative tool, than in absolute terms. Usually, one should look at a company's PE multiple compared to the industry the company is in, the sector the company is in, the indices it could be benchmarked against, as well as the overall market.