Understanding PE and PB ratio in Mutual Funds

Understanding the essential metrics is vital for mutual funds investors because these figures evaluate both performance and valuation of fund assets. The fundamental metrics required to analyze fundamental asset valuations include PE (Price-to-Earnings Ratio) and PB (Price-to-Book Ratio). Investors and fund managers regularly apply these ratios to determine if stock prices exceed market value or fall below it or maintain reasonable value. The following guide examines PE and PB definitions together with their calculation processes and their vital role in mutual fund assessment.

What is PE (Price-to-Earnings Ratio)?

The Price-to-Earnings Ratio serves as a valuation metric which connects a company’s present stock price to its earnings per share (EPS). The assessment tool of PE remains among the most commonly used instruments for determining stock valuation levels.

How is PE Ratio Calculated?

The formula for PE Ratio is:

PE Ratio = Current Market Price per Share / Earnings per Share (EPS)

• Current Market Price per Share:The price at which the stock is currently trading.
• Earnings per Share (EPS):The Company’s net profit divided by the number of outstanding shares.

For example, if a company’s stock is trading at ₹200 and its EPS is ₹20, the PE Ratio would be 10 (₹200 / ₹20).

What Does PE Ratio Indicate?

• When a stock price ratio exceeds normal levels it might signal either overvaluation or expected future high growth potential.
• A low PE ratio signals potential undervaluing of stocks but also indicates possible difficulties affecting the company.
• The PE ratio for mutual fund investments represents a weighted average of all the component stocks in their individual portfolios.

Thumb rule for PE ratio

• The acceptable PE range for large-cap mutual fund investments stands at 17-22. Above 22 indicates possible overvaluation.
• Multi cap/Flexi cap funds feature a wide PE range at 19-26 due to their investments across large, medium and small-cap stocks.
• The price-to-earnings ratios of mid-cap funds typically fall between 20-30 because of their potential high growth attributes. When the PE Ratio surpasses 30 it suggests potential worrying scenarios.
• Small-cap funds allocate investments into emerging companies which typically have PE ratios between 25-50.

Fact: The average PE ratio of the Nifty 50 index is around 20.5

What is PB (Price-to-Book Ratio)?

The Price-to-Book Ratio (PB Ratio) is one more of the valuation tools that enable to compare the market price to the book value per share. The book value is the net worth of a company, total assets minus intangible assets or liabilities.

How is PB Ratio Calculated?

The formula for PB Ratio is:

PB Ratio = Current Market Price per Share / Book Value per Share

• Current Market Price per Share:The price at which the stock is currently trading.
• Book Value per Share:The company’s net asset value divided by the number of outstanding shares.

For example, if a company’s stock is trading at ₹300 and its book value per share is ₹75, the PB Ratio would be 4 (₹300 / ₹75).

What Does PB Ratio Indicate?

• High PB Ratio: A high price-to-book ratio suggests stock price overvaluation or projected significant growth.
• Low PB Ratio: A ratio of PB below norm suggests either undervalued stock properties or suboptimal utilization of company resources. A mutual fund’s PB ratio represents the mathematical average of PB ratios across all stocks in its investment pool.
• Stat Alert: The average PB ratio of the Nifty 50 index is 3.4