Introduction

The basic objective for a business organization is to maximize its market price of share (MPS). Now, many times, in spite of the performing very well in a particular year and giving good Earning Per Share (EPS) to the Shareholders, the company’s MPS may not increase as per its expectations. This is because of the reason that Company’s MPS is a product of company’s Performance i.e.; EPS and Price Earning Ratio (P/E) i.e.; how much times of the EPS, the public is ready to pay to get the share of that particular company. For ex. If EPS of a company were 2 and P/E ratio of 10 then the MPS of the organization would be 20.

Factors affecting P/E Ratio of a company

P/E Ratio of an organization depends on many factors such as:

Growth

It is for sure that better the growth prospects of the company, more the people would be willing to be the part of that particular company even at a higher cost. This is because of difference in Return of Equity of a company, which has better growth prospects, and company achieving null growth.

Return of Equity = Current Return + Capital Appreciation

Current return, which is the earning of dividend, is the incidental objective behind investment in equity and the company having better growth prospects may give fewer dividends then the company in which no growth is there. This is because the basic objective of investment in equity is Capital Appreciation. Capital Appreciation is the increase in the market price of the share, which depends on the growth prospects of the company.

Also, if current return had been the main objective then it would have been better to go for the debt market of deposits (which gives higher return at very low or practically no risk).

Here it should be remembered that if:

• Company’s Actual Growth Rate > Market Growth Rate, then there is more than normal appreciation in the value of Market Price of Share.
• Company’s Actual Growth Rate < Market Growth Rate, then there is less than normal appreciation or downfall in the value of Market Price of Share.
• Company’s Actual Growth Rate = Market Growth Rate, then there is normal appreciation in the value of Market Price of Share.

We know that P/E Ratio = MPS (Price the people are willing to pay)/ EPS (Remains constant)

Hence, it can be concluded that better the growth prospects, the EPS remaining constant better would be increase in the Market Price of the shares. This is because of the fact that better the growth prospects better would be increase in P/E Ratio of the organization

Risk

Risk is basically measured in the terms of Cut off Rate = Risk Free Rate of Return + Reward for Risk. This cut off rate is also called as the expected rate of return because higher the risk the more would be the expected rate of return.

Also, the higher the risk would be, the lesser the people the people would be willing to invest in equity shares. Hence, higher the Cut off Rate, lower would be the P/E ratio i.e.; P/E = 1/ COR (Cut off Rate) 

Past Track Record/ Antecedents associated with the Company

Past Track Record and Antecedents associated with the companies are major factors that determine consumer trust and willingness to invest in a particular company (and hence increasing the P/E Ratio). Also, this would help to determine that whether the company has better growth prospects or not.

This head would include the promoters of the company, if the company is new and management, which would be the basis of past track record, if the company is an existing company.

If the company has a good past record and excellent antecedents then its P/E multiple would very high then other companies since people feel that risk is very less hence: -

·         No reward for risk is required hence cut off rate would be low and hence P/E Ratio would be high (P/E = 1/COR).

·         Growth prospects are very high since excellent management is attached with the company that has proved its worth in the past.

Hence, it can be concluded that if public confidence about the management is good, then people would like to invest in equity of that particular company irrespective of the fact that price is very high. Hence, the P/E Ratio of such company would also be very high.

Government Vision/ Approach

Government vision and approach about the particular industry and company also affects the P/E ratio to a large extent. For example, In India, TISCO, where even if the management is of very high standard, but due to loads of government restrictions, is not able to deliver high P/E ratio.

Also, Perception of people about the prospective policies of government i.e.; whether they are industry friendly or not etc. is also of much importance. For example, In India as soon as NDA lost elections and UPA won, there was crash in stock market since people thought that the policies of the new government would not be industry friendly, and P/E Ratio of many companies came down to a large extent because of which the Finance Minister had to came out with press release that their policies would be industry friendly.

Market feeling about performance of economy in general

Performance of economy in general effects on many economic and natural factors such as monsoon etc. that have large impact on market, hence having large impact on MACRO P/E ratio i.e.; P/E ratio of the market, thereby affecting the P/E ratio of some organizations. For example, In India if monsoon is good in a particular year then P/E multiple of market increases which leads to increase in P/E ratio of a particular company because 2/3^rd customers are from rural areas and purchasing power of rural people is dependent on effectiveness of monsoon.

Hence, the business organization should not only aim at maximization of EPS but also should take care of P/E ratio that is affected by the factors enumerated above so as to ensure maximum MPS.