Why should you compare P/E ratio of companies?



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P/E ratio of a company is also compared with P/E ratio of that particular industry to which that company belongs, What is the significance of this comparison?
Does it really necessary to compare ?

3 Answer(s)


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Theoretically, the market price of a share(MPS or just P here) is the discounted value of all the future dividends to be paid by a company, in the view of the share holders (based on the performance of the company and its business environment). Dividends(EPS or just E here) paid by a company has a very good co relation to the earnings of each company. So theoretically, the PE ratio is affected based on the shareholders intuition of what will be the future earnings and dividends of a company. A higher PE ratio than the industry means the shareholders expect that company to have more earnings and distribute more dividend than the other companies in the industry.

It is not mandatory to compare, but it is a very good yard stick to compare companies!

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Thanks for answering my question and clearing my doubt but I have one more doubt that higher P/E ratio as compared to industry sometime means the share is overvalued /or lower P/E ratio as compared to industry means the share is undervalued?

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Karan - There is a reason the shares are overvalued. Typically its because the company is a market leader and produces higher returns. Sometimes the over-valuation could be really high and doesn't merit the cash flow fundamentals (like in the case of the tech industry). This is again a reason why you would want to compare the P/E across the industry. You will know if the company is trading at a premium and if it is being over valued.