The P/E is one of the most talked about ratios in the stock market. What does…

Concept. A valuation ratio measures a company's market value against a fundamental per-share quantity, so that shares of very different prices can be compared on one common scale. The most widely quoted valuation ratio divides the market price of a single share by the profit that one share earns in a year, which tells an investor how much is being paid for each rupee of annual earnings.

Applying it here. The abbreviation is read as the price-to-earnings ratio, and exam papers often print the same expansion with the singular word Earning; its two letters expand into exactly those two quantities:

• P stands for Price — the market price of one share as quoted on the stock exchange.

• E stands for Earnings — earnings per share (EPS), the company's annual net profit divided by the number of shares outstanding.

So the ratio is written as market price per share divided by earnings per share, and it is read as the number of rupees the market pays for one rupee of yearly earnings.

Worked example.

1. A share is quoted at Rs 200 on the exchange, so the price term is 200.

2. The company earns Rs 10 per share over the year, so the earnings term is 10.

3. Dividing gives 200 divided by 10 = 20, meaning the market is paying Rs 20 for every Rs 1 of annual earnings; a higher figure signals richer pricing relative to current profit.

Cross-check the other expansions.

• Profit against expenditure compares two internal income-statement figures and carries no market price at all, so it cannot value a share.

• Profit against earning compares two accounting names for nearly the same bottom-line amount, so the result sits near one and conveys no valuation information.

• Provisional against estimates compares a first-release number with a projected number, which belongs to budget and statistical revision, not to share pricing.