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Showing posts with label P/E Ratio. Show all posts
Showing posts with label P/E Ratio. Show all posts

Saturday, June 17, 2017

Evaluate P/E before Stock Purchase

A question that every investor must ask is when should I buy a particular stock?

The answer will vary somewhat depending on whether you are investing in a growth stock or a value stock.

Growth investors expect the company to continue a steep rate of earnings (or in some cases, revenue) growth in the near future. They buy with a certainty that, if growth continues as anticipated, the price of the stock will rise also.

Value investors look for stock trading at a price lower than it is inherently worth. They are willing to hold the stock for an extended period and reap a large profit when the market discovers this hidden gem and bids the stock price up.

Price/Earnings Ratio

Investors often turn for part of their decision-making to a close look at the stock’s price/earnings ratio or P/E.

The P/E is a measure of how much investors are willing to pay for the company’s earnings. You calculate the P/E by dividing the current stock price by its earnings per share.

It is important to note that using the P/E by itself doesn’t give you a complete (or in some cases accurate) picture of the stock’s value.

Several factors can change the P/E. First, earnings per share may not show a true picture of the company’s earnings thanks to monkeying around with the numbers.

How P/E Is Calculated

Second, P/E can be calculated using the previous four quarters of earnings or it may use projections for the next four quarters. The difference can be dramatic.

You also must remember that various economic and market factors can raise or lower the price of the stock.

Given all that, the P/E is still helpful as part of the process of deciding whether to buy a stock.

A stock’s P/E tells you what other investors are willing to spend for the company’s earnings. For example, a P/E of 15 says investors are willing to spend Rs. 15 for every Rs.1 of earnings.

A high P/E says that investors expect the stock to be a strong performer and are willing to pay a premium. A low P/E says the market has less confidence in the company’s long-term potential.

A low P/E may indicate investors sense trouble ahead for the company. It also may indicate that other investors have overlooked this stock and are not placing the correct value on it.

The Right P/E

But, what is high and what is low for a P/E?

The P/E becomes more meaningful when it is compared to a benchmark. In most cases, you will want to see how other companies in the same industry rank.

If other companies in the same industry, are reporting P/Es in the low 20s, but the company you are considering has a P/E of 10, you need to find out why.

This may be a buying opportunity if you don’t uncover problems.

A stock with a P/E higher than its peers may be overpriced.

So, the answer to the question of when to buy a stock (in particular, a value stock) is when the P/E is lower than its peers and you can find no significant problems with the company.

Friday, August 5, 2011

Price to Earning Ratio - P/E

If there is one number that people look at than more any other it is the Price to Earnings Ratio (P/E). The P/E is one of those numbers that investors throw around with great authority as if it told the whole story. Of course, it doesn’t tell the whole story (if it did, we wouldn’t need all the other numbers.)

The P/E looks at the relationship between the stock price and the company’s earnings. The P/E is the most popular metric of stock analysis, although it is far from the only one you should consider.

You calculate the P/E by taking the share price and dividing it by the company’s EPS.

P/E = Stock Price / EPS

For example, a company with a share price of Rs. 40 and an EPS of 8 would have a P/E of 5 (Rs. 40 / 8 = 5).

What does P/E tell you? The P/E gives you an idea of what the market is willing to pay for the company’s earnings. The higher the P/E the more the market is willing to pay for the company’s earnings. Some investors read a high P/E as an overpriced stock and that may be the case, however it can also indicate the market has high hopes for this stock’s future and has bid up the price.

Conversely, a low P/E may indicate a “vote of no confidence” by the market or it could mean this is a sleeper that the market has overlooked. Known as value stocks, many investors made their fortunes spotting these “diamonds in the rough” before the rest of the market discovered their true worth.

What is the “right” P/E? There is no correct answer to this question, because part of the answer depends on your willingness to pay for earnings. The more you are willing to pay, which means you believe the company has good long term prospects over and above its current position, the higher the “right” P/E is for that particular stock in your decision-making process. Another investor may not see the same value and think your “right” P/E is all wrong.

Saturday, October 23, 2010

Historical and Expected P/E Ratio of Indian Stock Market

P/E ratios in India during 1990 and 2005

As of December 31, 2009, there were 23 government-recognized stock exchanges in India and there were more than 9,700 companies listed on these exchanges. The Bombay Stock Exchange (BSE) lists about half of these companies (4,929).

BSE happens to be the oldest in Asia, having been established as "The Native Share & Stock Brokers Association" in 1875. As of December 31, 2009, the market capitalization of the companies listed on BSE was approximately USD 1,400 billion (approximately 1.1 times India’s annual GDP).

Since BSE has the most well-known indices within the Indian stock market, we focus on a few of these indices in this article: SENSEX (with a base of 100 in 1978-79), BSE-100, and BSE-500 (with a base of 1,000 in 1999 and comprising 500 listed companies in various Indian stock exchanges).

Ignoring dividends, both SENSEX and BSE-100 have grown by 13.4% annually in Indian Rupee terms during April 1, 1991 and March 2005. On March 31, 2005, SENSEX was valued at 6,492.82 (with a P/E ratio of 16.05) and BSE-100 was valued at 3,481.86 with a P/E ratio of 13.72. This growth rate can be partitioned into the following three components:

1. The companies comprising SENSEX and BSE-100 have individually grown at an average annual rate of 9% or more (in real terms) and 15% (in nominal terms).

2. As shown in the table 1 given below, the price-earnings ratio for companies listed in SENSEX went down from 19.68 in March 1991 to 16.05 in March 2005, i.e., an average drop of approximately 1.5% per year. Similarly, the price earnings ratio for companies listed in BSE-100 dropped by approximately 2.4% per year.

3. The difference between (1) and (2) approximates the average annual growth rate of SENSEX and BSE-100 of 13.4% as mentioned above.

Predictions regarding the Indian Stock Markets during 2005 and 2015

The following three main components are likely to result in a strong upward movement of Indian markets:

1. During April 2005 and March 2015, companies listed in SENSEX, BSE-100, and BSE-500 are expected to grow at an annual average rate of 11% (in real terms) and 17% (in nominal terms).

2. In March 31, 2005, the firms in SENSEX were trading at an average P/E ratio of 16.05 whereas they were trading at an average price earnings ratio of 22.8 during 1991 and 2005. Our analysis shows that by December 2015, these firms (that are part of SENSEX, BSE-100, and BSE-500) are likely to trade at an average P/E ratio of 22.8 also, partly because of volatility and partly because the annual growth rates of these companies is quite high when compared to their counterparts in the United States and other developed countries.

3. As a comparison, during the past fifteen years, an average firm in China’s stock market has been trading at an average price-earnings ratio of 23. Clearly, on one hand, since the stock markets in the United States are much bigger and more mature, the companies listed there likely to command a higher premium; on the other, since these earnings are computed on the “last twelve month” basis and since the companies in India (and other emerging countries) are growing more rapidly – as much as 7-8% more – than their counterparts in the United States, we believe that the SENSEX, BSE-100, and BSE-500 will trade at an average price/earnings ratio of 22.8 (during 2005 and 2015).

Friday, June 11, 2010

Good Company with High P/E Ratio

Good Company with High P/E Ratio

For a good company to be a good investment, it must be priced (valued) correctly.

Investors gain from a stock investment by buying at a price that is below the actual value. Over time, a good company will reward the investor with dividends and growth in the stock’s price. There is nothing wrong with wanting a piece of this type of company. The problem comes when you are a late arrival and the price of admission (stock price) has climbed too high.

Investors eager to get a piece of the action may bid up the stock’s price to a level where future price appreciation is uncertain. Too often, investors jump when they should stand back and take a hard look.

Ignoring dividends for a minute, you can get a rough idea of valuation by multiplying the earnings per share (EPS) by the price earnings ratio (P/E).

P/E Factor

Remember P/E is a factor of how much investors are willing to pay for earnings.

So if a company is earning Rs. 10 per share and the P/E is 25, the stock should be worth Rs. 250 per share. If earning don’t change, but the P/E drops to 20 (meaning investors are not so excited about the company’s future prospects), the stock should now be worth Rs. 200 per share.

This is the problem of paying too much for the stock - if investor sentiment turns - the stock falls. Investors can’t predict what the market will do and how that might influence the stock’s price. Focusing on buying a stock at a discount to its worth as an operating company will help protect you from speculative influences on market price.

Of course, P/E is not the only or even the best measure of a stock’s true value, but it does illustrate why buying high is a dangerous strategy.

Suggested Reading:

P/E Ratio - To determine relative value of Stock