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