PE Ratio - How prices are effected?

Many investors go by the EPS and PE ratio for a particular stock but sometimes things can drastically wrong or there can be surprising rewards in this.

Take the example of Infosys. Infosys was the favorite stock in IT pack even till 9 months back. Infosys had an EPS around 90 in FY06 and there was also a bonus of 1:1 and Infy moved to 3500 cum bonus commanding a PE of 40 on FY06 earnings.

In FY07 the EPS was 136 or ex-bonus it was 68. But the rupee effect started showing some effect and the PE ratio was now 34 only. Infy moved to a maximum price of 2400 Rs.

When the rupee started sliding further and Infy gave conservative guidance of 80 we are now seeing the stock at 1600 levels which means the PE ratio has come to 20. If only the rupee had not depreciated Infy should have ideally been around 2700 Rs to 3000 Rs.

This is how a small change in PE ratio can effect the share price of even a blue chip company.

Take another example of Reliance Industries. Reliance used to command a PE of 10 till 2004 and when the EPS was 60 Rs stock was quoting around 600 Rs or something like this.

It all changed in 2005 after the demerger. PE ratio of Reliance started increasing and now with annual EPS expected around 100, Reliance is close to commanding 30 PE.

Reliance Petro EPS is not known but only we have few analysts estimates. It was expected to be 5 but with increasing oil prices I believe this can be even 10 in the first year. Giving a PE ratio of 50, Reliance Petro can move up to 500 Rs by end of FY09 but market tends to give more PE for stocks and sometimes it can even be 100 also which means Reliance Petro can move upto 1000 Rs by FY09. This is based on presumption that oil prices will keep moving up and stay around $100 atleast. What happens if they drop back to 70 levels? Markets will then give less PE ratio and even say 30 PE and price can come down to 300 Rs from 1000 Rs. This is how PE ratio can effect stock price.

Consider an interesting scenario for Infosys. If govt is forced to increase petrol prices and if petrol prices move up by 6 Rs atleast then inflation will increase and rupee will start downward trend and dollar moves up. If rupee touches 42 to 43 level again, Market will give higher PE valuation to Infy and in Fy09 if Infy can clock an EPS of 100 and PE ratio is 30 then the price can be 3000 Rs. That is almost double from current levels. But the million dollar question is....when will the rupee go down? Any guesses ???????????