Question

Stock A and stock B are in the same industry and are competitors to each other. Stock A has a P/E ratio of 20, and stock B has a P/E ratio of 5. Assume they are performing as well as each other, which one is more likely to be undervalued?

Answer 1

Price Earnings Ratio (P/E ratio) = Stock Price / Earnings per share

Price Earnings Ratio helps to determine whether stock of a company is undervalued or overvalued.

The Earnings per share or EPS only shows the profitability of the year but the Price Earnings ratio takes into consideration the future growth and risk related to the stock as well.

When we are comparing two stocks and we have to decide which stock is overvalued and which one is undervalued it is to be noted that

• A stock with a higher PE ratio is considered overvalued
• A stock with a lower PE ratio is considered undervalued

Therefore Stock B with the P/E ratio of 5 is more likely to be undervalued when compared to Stock A which has a P/E ratio of 20.