Like other local newspapers, the Star publishes the price earnings ratio on the
daily quote sheet for local stocks.
The price/earnings ratio, commonly identified as P/E, PER or the earnings multiple
basically relates a company with its earnings and sales growth.
Simply, the P/E is calculated by dividing the market share price by the company's
earnings per share (EPS). The P/E tells an investor how many times the price is a
multiple of the earnings The P/E normally rises in tandem with the stock price, meaning
that when the stock price rises, the P/E will rise too and vice versa.
The P/E ratio is widely used as a measurement by fundamental-driven investors to
identify good investment opportunities. You may be one of those who use the measurement
as part of your investment tools.
Calculating the P/E is simple but the more complicated task is comparing it with
other figures and interpreting them. Analysts employed by stockbroking firms spend
most of their times evaluating the performance of companies of various backgrounds.
One of their routine tasks of course includes evaluating the P/Es of these companies.
Different analysts have different interpretations of the P/Es. So how do you interpret
the P/E of a company? Let us take an example. Suppose there are two companies listed
on the Kuala Lumpur Stock Exchange (KLSE), Company A and Company B with the P/Es
of 5 and 20 respectively.
Analysts may interpret that Company A is selling 5 times its earnings while Company
B is selling 20 times its earnings usually written as 5x or 20x. Company A's P/E
of 5x means that the market values the stock at RM5 for every RM1 of earnings while
Company B is valued at RM20 for every RM1 earnings.
An analyst may find that Company A is more attractive since it costs less for the
same earnings of RM1. Another analyst may reason that Company B is more attractive
as higher P/E means that the stock is more valuable in that it has a higher potential
to deliver attractive returns.
So, which one is the best? Low or high P/Es? High P/E basically means having high
expectations for earnings. If the earnings growth expectations are not met as implied
by the high P/E maybe due to certain factors such as ineffective management or poor
marketing efforts, investors are most likely to dump the stock in the future.
High P/E stocks do not necessarily outperform the market and investors face the danger
of buying at peaks. However, it is also equally true that high P/Es generally reflect
investors confidence in the stocks. In many cases, some of these stocks do manage
to deliver good and secured returns over the long-term.