NEPSE What ?

NEPSE Jargon: P/E Ratio ?

Published by Octron on February 24, 2009

The P/E ratio (price-to-earnings ratio) of a stock (also called its “earnings multiple”, or simply “multiple”, “P/E”, or “PE”) is a measure of the price paid for a share relative to the annual income or profit earned by the firm per share. A higher P/E ratio means that investors are paying more for each unit of income. It is a valuation ratio included in other financial ratios. The reciprocal of the PE ratio is known as the earnings yield. The earnings yield is an estimate of expected return to be earned from holding the stock if we accept certain restrictive assumptions.

The price per share (numerator) is the market price of a single share of the stock. The earnings per share (denominator) is the net income of the company for the most recent 12 month period (for “Trailing P/E” or “P/E ttm”, which is most common), divided by number of shares outstanding. The P/E ratio can also be calculated by dividing the company’s market capitalization by its total annual earnings.

For example, if stock A is trading at Rs. 2400 and the earnings per share for the most recent 12 month period is Rs. 30, then stock A has a P/E ratio of 2400/30 or 80. Put another way, the purchaser of stock A is paying 80 for every rupee of earnings. Companies with losses (negative earnings) or no profit have an undefined P/E ratio (usually shown as Not applicable or “N/A”); sometimes, however, a negative P/E ratio may be shown.

By comparing price and earnings per share for a company, one can analyze the market’s stock valuation of a company and its shares relative to the income the company is actually generating.[citation needed] Investors can use the P/E ratio to compare the value of stocks: if one stock has a P/E twice that of another stock, all things being equal (especially the earnings growth rate), it is a less attractive investment. Companies are rarely equal, however, and comparisons between industries, companies, and time periods may be misleading.

P/E Ratios & Interpretations

N/A: A company with no earnings has an undefined P/E ratio. By convention, companies with losses (negative earnings) are usually treated as having an undefined P/E ratio, although a negative P/E ratio can be mathematically determined.

0–10: Either the stock is undervalued or the company’s earnings are thought to be in decline. Alternatively, current earnings may be substantially above historic trends or the company may have profited from selling assets.

10–17: For many companies a P/E ratio in this range may be considered fair value.

17–25: Either the stock is overvalued or the company’s earnings have increased since the last earnings figure was published. The stock may also be a growth stock with earnings expected to increase substantially in future.

25+: A company whose shares have a very high P/E may have high expected future growth in earnings or the stock may be the subject of a speculative bubble.

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