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What Is Sensex Price-To-Earnings (PE) Ratio And Forward PE?

Let us understand what the PE ratio means in terms of individual companies, before talking about the Sensex PE and forward PE. The PE ratio is used to determine whether a company is overvalued, undervalued or rightly valued. It gives an idea of how much an investor is willing to pay for every `1profit earned by the company. So, a PE of 20 means the investor is ready to pay `20 for every `1that the company earns in profits. PE is calculated in 'multiple' or 'times'. Being the key benchmark index, the Sensex PE is used as a key measure of valuation of the Indian markets. A weighted average of individual PEs of companies in the Sensex makes the Sensex PE. When the Sensex PE is calculated for the year ahead of the current financial year, it is called the forward PE. Since markets analysts consider the future valuations, they take into account the Sensex's one-year forward PE multiples before making investment decisions.

How are they calculated?

The current market price of a stock divided by its *earnings per share (EPS) will give the PE of an individual company. The Sensex's PE can be calculated in more than one way. The simplest method of doing it is dividing the Sensex's total market capitalisation by the Sensex's total net profit. We get the one-year forward PE for the market by dividing the Sensex's total market capitalisation by the Sensex's projected one-year forward total net profit.

Why is this ratio important?

Investors can compare a company's relative valuation like company versus peer, company versus sector and company versus its past performance on the basis of its PE. In most cases, a lower PE along with strong fundamentals signifies a value pick. But, PEs may vary according to sectors. For instance, sectors like commodities inherently trade at lower PEs while those like IT and FMCG trade at higher PEs. Institutional investors, mainly foreign Institutional investors, who have been driving the Indian equity markets, compare the benchmark index PEs of different countries before deciding on which one will generate higher values at a later date.

Should retail investors track Sensex PE?

Every investor needs to give due consideration to the valuations before investing in the markets. A fair PE multiple reflects the profitability and the growth prospects of the company. Thus, when the markets trade at a huge premium, investors should be wary of taking further exposure. In case of a discount to the fair valuations and support of strong fundamentals, investors could increase their exposure in the markets. *Net profit divided by the number of shares will give you the EPS of a stock

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