Sunday, December 11, 2011

Using Price per Earning (P/E) Ratio to Analyse Stock

Price per earning or P/E ratio is another useful financial indicator that you can use to analyse your stocks.  It basically tells how many years it takes for you to earn back one share price that you buy. 2 assumptions are being made here for simplification:

  • You do not sell your stock
  • The stock dividend equals to the earning per share. 
For example, company A has the share price of $10 and the earning per share is $2 per year, you will need 5 years to earn back $10.  However B has the share price of $20 with the same earning per share (i.e. $2), you will need 10 years to earn back the $20. This tells you in fact company B is over-priced and company A is under-valued. In short, the lower the P/E ratio value, the better. The P/E ratio formula is:

P/E Ratio = Share Price / Earning Per Share (EPS)

Note 1: For more information on EPS, you can read my previous post: Using EPS to Analyse Stock

The earning per share should be based on yearly and NOT quarterly.  Another important thing about this EPS is, it is better to use the latest EPS rather than the one you get in the annual report unless you really don’t have a choice or you simply lazy. The technical term for this is called “Trailing Twelve Months” or TTM which means the most recently past 12 months.

Where to get P/E ratio data?

If you do not want to calculate yourself and would like to get the latest information about P/E ratio, you can just search for P/E ratio (TTM). Usually when you see P/E ratio without mentioning the “TTM”, it means the EPS is based on the last fiscal year. For example when I look at my stock trading online account on a particular stocks, the P/E ratio information doesn’t have the TTM. This means the P/E ratio is based on the last fiscal year. In short:

P/E Ratio = Current Share Price / EPS based on the last fiscal year (e.g. as stated in annual report)

P/E Ratio (TTM) = Current Share Price / EPS based on the most recently past 12 months (e.g. latest last 4 quarter)

Airasia Bhd. vs MAS Bhd. (Case Study)

The first this is to get the P/E ratio(TTM) for both Airasia Bhd. and MAS Bhd. However, you will notice that there is no P/E ratio(TTM) for MAS. This is because MAS is making lost in the past quarters. In other word, the EPS (TTM) for MAS is negative. In this case, you cannot compare the P/E ratio between these 2 companies.
  • P/E ratio (TTM) for AiraSia = 13.60
  • P/E ratio (TTM) for MAS = N/A
So let’s look at without the TTM which is based on the last year 2010 EPS data. You will get the following:
  • P/E Ratio for Airasia Bhd =  9.56 (Under-valued)
  • P/E Ratio for Mas Bhd = 18.67 (Over-priced)
Even if we use the last year EPS data to compare this 2 companies, the P/E ratio tells that Airasia is under-valued as compared to MAS and MAS is over-priced as compared to Airasia. Given that EPS analysis for these 2 companies and also based on the poor performance of MAS (i.e. making lost in the past few quarters), there is no reason to buy MAS stock.


Earning per share tells you the company performance but we need to study their track record by looking at the past years and look at the EPS growth instead. After that, you can perform use the price per earning ratio or P/E ratio to compare companies that are in the same industry. The lowest P/E ratio basically means it is under-valued and ot is good to buy. If both EPS and P/E ratio analysis show positive for that particular stock (e.g. in this case is Airasia), that means based on the fundamental analysis, we should buy that share
The challenging part is if you get good EPS but bad P/E ratio and not both. Which one has the higher weightage? I will probably wait until the stock price goes down first since the EPS is still good. If EPS is bad, I probably won’t got for this stock at all. Does this make sense?

P/S: I’m still learning but I find this EPS and P/E ratio analysis are pretty awesome but require some amount of works before you decide to buy the share. I welcome you to share your investing experience here especially you are the fundamental investor. Other than EPS and P/E ratio, what else do you look at?


Alvin Lim said...

i used to refer a lot to EPS and PE...until our stock market went crazy for last 1 year or so. there are still good stocks with very good EPS n PE...but the problem is, nobody ever bother to look at them. and if there's nobody who is interested, the price will stay stagnant most of the time.

PE and EPS are both important, no doubt. But also important to pick stocks which are not overly popular..but not overly unknown as well. Compare few OK to popular stocks in the same industry, and compare the EPS and PE. thats what I normally do (I think. ahha).

ChampDog said...

How can you tell whether is overly popular?

LCF said...

Nice one man. I too,did my own excel sheet to calculate financial ratios, P/E is one of them, before coming to its 'fair value' as value investor call it. It's good guideline when I started out investing, and I told myself - stock investing is really not rocket science at all although I'm an engineer. But so many things come into play - macroeconomics, support/resistance, earnings surprise/miss and competition. Especially competition. Who would have thought the grand daddy of smartphones being smacked down by Apple Iphone in 2008, with price of $ 16/share now. RIM was such a value stock only 3 years ago.

ChampDog said...

I don't know you're an engineer too. :) Have seen lately an engineer video from SG about fast dating? :) If not, worth to watch it! :)

That's why sometimes investing or economy is too complex and unpredictable where you look at the it from fundamental perspective has no longer works or effective. I"m not sure how true is this but some believe fundamental analysis has no longer that useful.

LCF said...

ChampDog, yeah I watched it. He does look like an engineer, but the lady, not so much of a civil engr :D . I agree it's a good one

alternative investments said...

P/E is one of the best factors in evaluating stocks. Over the long run, one will alm ost always do better in low P/E dividend paying stocks then in high P/E growth stocks that do not pay much in dividends. Yes, there may be times that the high flyers will outperform, but over the long run a portfolio of low P/E dividend payers will be less volatile and achieve higher returns.

ChampDog said...

@LCF, lol can tell from the look. :) Apparently a lot of engineers share this link once it was posted. :)

@alternative investments, I think I agree with you. Fundamental should work for long run. Long run here I mean could be more than 5 years. What is your long run definition? :)

Other than using the fundamental, we also need to look at the recession indicator such as the GDP growth. Then look at the market index (e.g. KLCI index). That's what I think.

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