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 Can someone please explain P/E.....mero dimag ma ghusnai aatena
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Posted on 01-31-13 5:32 PM     Reply [Subscribe]
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  Can someone please explain me P/E ratio......
    i k now its out there  and i have researched it million times but still i dont get it. 
      the major difference between P/E being above 20 and lets say below 2? 
 thank you so much 
Posted on 02-01-13 12:08 AM     [Snapshot: 130]     Reply [Subscribe]
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Sure - my pleasure.

P/E ratio is a simple method to gauge the relative value of a stock (against another stock of a similar industry, etc.)

Best to work through an example:

Let's say Stock A has the following attributes with the earnings from the most recent fiscal year:
Market Cap =  $40m 
Annual earnings = $2m
P/E = $40 / $2 = 20

And Stock B has the following attributes:
Market Cap =  $40m 
Annual earnings = $20m
P/E = $40 / $20 = 2

So if you were an investor you'd want to pick Stock B because you'd pay only $40 million for a company that earns $20 million in profits versus Stock A which only earns $2 million for the same market price.

You can also calculate the P/E on a per share basis - you just have to divide each of the attribute by number of shares outstanding. Sometimes research reports will also use leading P/E which means the earnings are estimated into the future. In our case above it's a trailing P/E since we've used the earnings from the past.

Posted on 02-01-13 9:49 AM     [Snapshot: 331]     Reply [Subscribe]
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I hope JavaBeans explanation helped; if not, I will try my version below:

First of all P/E ratio that you see in most of the finance sites are the Trailing P/E. There are Current and Forward P/E but that's not important here, so let's talk about the most common P/E: Trailing P/E

First the ratio that you already are familiar with:
 P/E = (Current stock price) / (Earnings per share from the last four quarters combined).

Note: I haven't seen JavaBean's version (market cap/annual earnings) but I am sure it is used as fundamentally, the ratio is almost similar.


So what is the ratio stating?
Let me give you a real life example although P/E is strictly used in stock markets and the example below is only for demonstration purpose:

Real life Example:
Say, you want to invest in a gas station which is worth 300K and the station earns 5000 a month (i.e. 15,000 a quarter and 60,000 in last four quarters).

Then hypothetically, P/E for your gas station would be 300,000/60,000 = 5.

What is it saying?

Think about it;  it's saying in 5 years of time you will be able to recoup the investment you put in. So, a smaller P/E would be good right? Lesser time to recoup? Yes, in this situation.

But now, assume that you want to sell your gas station. You look at your P/E and while smaller P/E was good for you originally, it won't look so good now because you wanted more worth for your gas station. Say you wanted to sell it for $600,000. Now your P/E becomes = 600,000/ 60,000 = 10. So, a higher P/E is actually better for you now. If you were to price your station for 1.2M, your P/E would be work 20.

Now hold your horses!! An investor who is looking at your gas station and wants to buy it so he can later sell it, would like a reasonable P/E.
Low P/E could mean that the denominator is high (i.e. gas station is earning a lot more) OR it could mean the numerator is low (gas station is worth really low). Why is it worth low? Are other people not interested in it? They don't have confidence in the gas station??

How about a high P/E? Now denominator is low (i.e. gas station isn't earning much) or it's numerator is high (it is worth more). It could again be a good thing or a bad thing as, it could have been priced artificially too high OR investors have enough confidence in the station even though it is not earning much.

What I just proved is a P/E ratio in itself doesn't say much. A low P/E ratio could be a good thing or a bad thing, same applies to high P/E ratio.

So what do you use this for then?

  • You combine P/E with other market indicators.
  • You typically compare P/E of a company to another company within the same industry. P/Es for companies from different industries do not mean much.

Typically you will see P/E value of 15 for many companies. P/E around this value typically mean the valuation might have matured (an established brand), especially if the P/E has stayed steady for last few years. If P/E is too low, that means worth of the P/E is too low and could hint that investors don't have much confidence in the company since they expect lesser return in the future. If P/E is too high, it could mean the valuation of the company has been over inflated and it could crash.


Hope this helps.

Posted on 02-01-13 12:41 PM     [Snapshot: 449]     Reply [Subscribe]
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Note: I haven't seen JavaBean's version (market cap/annual earnings) but I am sure it is used as fundamentally, the ratio is almost similar.

ratio is the same.

Posted on 02-01-13 12:47 PM     [Snapshot: 473]     Reply [Subscribe]
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Posted on 02-01-13 12:54 PM     [Snapshot: 480]     Reply [Subscribe]
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And Mr. Expert, before I explain to you why IT IS NOT THE SAME, why don't you explain why it is the same as you claim above . I just want to make sure its worth my time explaining it.
Posted on 02-01-13 2:38 PM     [Snapshot: 531]     Reply [Subscribe]
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Not going to waste my time debating a chartist/techinican with perhaps a hole in his sole :o)
Posted on 02-01-13 2:59 PM     [Snapshot: 553]     Reply [Subscribe]
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Lol. That's fine man, you had time to critic on my comment but no time to justify the criticism. That's cool. Not sure how you found out about hole in my sole as I really need to buy a new shoes badly.

But maybe urban khasi, who is nowhere to be found now, would like to know. So let me explain.

Actually, Wikipedia link that the another gentleman posted in a different thread with same title, explains it far better:

Some people mistakenly use the formula market capitalization / net income to calculate the P/E ratio. This formula will often give the same answer as market price / earnings per share, but if new capital has been issued it will give the wrong answer, as market capitalization = market price × current number of shares whereas earnings per share= net income / weighted average number of shares.

Lesson learned: understand before you criticize.

Posted on 02-01-13 9:52 PM     [Snapshot: 675]     Reply [Subscribe]
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That's a nice example kiddo - but I believe the rest of the details are unnecessary at this stage. The OP's question was simply to understand the major difference between a high and low PE. I believe a simple straight forward example is most effective to distill a new concept. For productive and competence purposes - if the OP is satisfied - an essay can be spared.

My example above was a back-of-the-envelope type explanation - intentionally concise for ease of understanding - as it has no mention of new capital, smoothed or adjusted earnings, off-balance sheet adjustments, etc. And the example is not wrong in itself. I think that's what wit's end is referring to as the two different versions are essentially the same given an algebraic manipulation. If we do however take these additional details into account, including new captial, then the ratio will be in error as the recent earnings need to properly reflect the injection of fresh capital in the middle of its opearting cycle. Hence, there are quite a few variations of P/E ratios - and an analyst ususally runs through a number of scenarios and sensitivity analysis, depending on the sector, before deciding on a suitable model. I've also seen some analyst use basic EPS versus diluted EPS as the denominator - which can also make P/E ratios differ.

Also, I do not (and would not) apply P/E ratios to relatively value a firm since it uses market price and accounting earnings (due diligence is a must for both as they are fickle at best) - but I understand how the ratio works. The following ratios also have the same fallacies: P/Book, P/Sales, P/Cash Flow, Dividend/P, P/Operating Earnings, P/EV - notice how all of them assume that the market is precisely right. And we know that is not true.

Posted on 02-01-13 10:41 PM     [Snapshot: 722]     Reply [Subscribe]
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"An essay can be spared"

Wow...just wow.
Last edited: 01-Feb-13 10:57 PM

Posted on 02-02-13 10:14 PM     [Snapshot: 954]     Reply [Subscribe]
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My apologies kiddo - I didn't mean for it to be offensive. It was just an attempt to say that our ideas / comments might be helpful to the OP and other readers if we stick to what's being asked - but I know that everyone has their own style of writing which sometime could entail a bit lenghty and verbose side of things. In that respect, I am definitely in the wrong. Sometimes I forget that I am in a public forum.

Posted on 02-03-13 2:03 PM     [Snapshot: 1141]     Reply [Subscribe]
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NP JavaBeans. Yeah, I didn't expect that at all and was just surprised coming from you. No harms done, and trust me I was only trying to dumb it down a little to make it more understandable.
Funny thing is the guy who asked the questIon is nowhere to be found and we are left discussing amongst each other. Typical Sajha.
Posted on 10-07-19 3:32 PM     [Snapshot: 3880]     Reply [Subscribe]
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pr is ration is simple wathc youtoube

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