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<p>When investing in the market, opting for stocks with reasonable valuations and a higher margin of safety may provide a safety cushion. <strong>P/E Ratio </strong>(Price to Earnings Ratio) can help the investors gauge the valuation multiples for a given company or scheme, which can then be used to compare other companies or mutual fund schemes.</p>
<p><strong>What is P/E ratio?</strong></p>
<p>Deciding about the market valuations by looking at the share's market price alone is inappropriate. For instance, an equity share trading at Rs. 1000 per share could still be inexpensive considering its expected earnings growth potential. Similarly, an equity share of Rs. 11 may not be economical as the earnings growth history of the company may be weak.</p>
<p><strong>P/E ratio means</strong> the ratio of a company’s current share price in relation to it’s earnings per share. It represents the market valuation as a multiple of the company's annual earnings. It is one of the yardsticks to measure and compare the investment valuations of different companies.</p>
<p><strong>Calculating the P/E ratio of mutual fund schemes</strong></p>
<p>To calculate the P/E ratio of an individual security, the prevailing market price is divided by the company's annualized Earnings Per Share (EPS). For example, if the company has an EPS of Rs. 20 and the market price of the share is Rs. 75, the Price to Earnings Ratio of the company is 3.75 (75 divided by 20).</p>
<p>Once the P/E Ratio has been calculated for all the securities in the portfolio, the mutual fund scheme's P/E ratio is calculated by taking the P/E Ratio of each security and then assigning weights as per their weightage in the portfolio.</p>
<p><strong>What does P/E ratio signify?</strong></p>
<p>When the PE ratio is less than one, the company is considered to be undervalued. In contrast, if the P/E ratio is higher, the company is valued in the markets at higher valuation multiples. One can use the P/E ratios of different companies to objectively compare the two companies' valuations.<br />
A high P/E ratio indicates that investors are willing pay more for each unit of earnings of the particular stock and are expecting higher earnings growth in the future. While it is easier for the investors to calculate the P/E ratio of individual stocks, the P/E Ratio for the mutual fund schemes are disclosed by mutual funds in their monthly fund fact sheet for the investors' information.</p>
<p>Further, suppose the P/E ratio is lower than the benchmark index or peer schemes. In that case, it may imply that the scheme portfolio is biased toward the companies with valuation discounts.</p>
<p><strong>Shortcomings of P/E ratio</strong></p>
<p>While P/E ratio is a crucial indicator of portfolio valuations, here are a few shortcomings of the PE ratio:</p>
<ol>
<li>P/E ratio cannot be considered in isolation and must be seen along with the category averages or industry averages.</li>
<li>The P/E is typically calculated by measuring historical earnings or trailing earnings. Historical earnings are not of much use to investors because they reveal little about future earnings. Further, predicting the future earnings growth is complicated and are prone to errors of estimate.</li>
<li>Whether a specific level of P/E ratio is high or low depends upon the industry average or P/E valuation multiples of peer companies. The ideal P/E ratio range may also differ from one sector to another. Thus, a 'one size fits all' strategy cannot be implemented with P/E ratios of different companies across various sectors.</li>
</ol>
<p>Mutual fund schemes may be evaluated through P/E ratio in conjunction with other financial information like price to book ratio, return on equity, price/earnings to growth ratio etc. available for the schemes.</p>
<p>Disclaimer-</p>
<p><strong>Mutual Fund investments are subject to market risks, read all scheme related documents carefully.</strong></p>
<p>To know about the KYC documentary requirements and procedure for change of address, phone number, bank details, etc. please visit <a href="https://www.utimf.com/servicerequest/kyc">https://www.utimf.com/service…;. Please deal with only registered Mutual funds, details of which can be verified on the SEBI website under "Intermediaries/market Infrastructure Institutions". All complaints regarding UTI Mutual Fund can be directed towards <a href="mailto:service@uti.co.in">service@uti.co.in</a> and/or visit www.scores.gov.in (SEBI SCORES portal). This material is part of Investor Education and awareness initiative of UTI Mutual Fund.</p>