Price Earning (P/E) Ratio
Price/Earning (P/E) ratio is defined as Market Value per Share / Earnings per Share (EPS). Market Value Per Share is simply the current trading price of the share, while EPS is gathered from the Earning per share from the last 4 quarter. Price/EPS (last 4 quarter) is called Trailing P/E while Price/EPS (next 4 quarter projection) is called Forward P/E.
Trailing P/E can easily be obtained from the live quote of your trading platform, see below.
The general idea is that the higher the P/E, the over priced a stock is. This does not mean that we should only choose stocks with low P/E. There are many different ways of looking into P/E and there is no hard and fast rule to do stock picking just using P/E ratio alone. I usually screen out stocks with extremely high P/E. So, how high is high? A rule of thumb would be to compare it against the P/E of the sector this stock is in. Sector P/E can be obtained from your trading live quote too. For example, AZRB which is in Construction sector has P/E of 53.60. The current P/E for Construction sector is 13.14. So, do you think AZRB is priced too high relative to its peer? I would think so. Unless AZRB’s earning is improved or its price is dropped significantly, there is no way its P/E will be normalized to ‘teen’ level of 13 or 14.
Referring to the same diagram above, UOADEV has P/E of 7.06, do I say it is underpriced? No until I compare it with its sector average. UOADEV is in Properties sector which has current P/E of 8.38. With that, I can concur that UOADEV is resonably priced in relative to its peers. As I mentioned, P/E is not a sole decisive factor for buying into a particular stock. Hence, I can only say that it can be short-listed and warrants a further progress into the next stage of screening, if that is indeed what I am interested in,
One additional note to this is that, you can translate P/E ratio to a very interesting layman term, i.e. how many years does it take for my stock to generate earning that pays off my initial capital. i.e. if price of stock is 3.00, and P/E is 7.5, it means it takes 7.5 years for this stock to generate earning equivalent to 3.00 which is my cost price. Of course this can only be a guideline, discounting all other circumstances which might happen to the company. But it is enough to scare you off from buying into a stock with P/E of says 52 which simply means that your break even point of a whopping 52 years! Think about it.
You may notice some companies are without P/E. It could mean 2 things – a) the counter is new and it hasn’t had its first earning declared, or b) it is a loss making company, obviously a +ve price with -ve or 0 earning (denominator) translates to infinity or -ve P/E. You can’t have -ve P/E therefore it is shown as blank in the P/E column.