There are so many factors while checking and evaluation of stock
which must be considered by selecting and investing in a stock. There are
following factors about which must be studied before investment in a stock:-
(i)
Price to
Earnings Ratio
(ii)
Beta
(iii)
Earnings per
share
(iv)
Average
equity
In this article we will study
about Price to earnings ratio
Price to earnings ratio- P/E ratio which is measure of its current
share price relative to its per share earnings.
There is following methodology of
calculating Price-Earnings ratio:-
If a share is trading at 300 Rs /Share and its earnings over
financial year comes out to be 3 Rs/Share. Then P/E ratio of stock will be
300/3= 100.
Price-earnings ratio is also known as earning multiple.
Trailing P/E Ratio:-
Earnings per share is calculated from last four quarters, this
form of P/E ratio is known as trailing P/E ratio. Trailing P/E ratio can be
calculated by deducting share value of company at staring of financial year
period from share value of company at end of financial year after considering
stock split if any takes place during that period.
Forward P/E Ratio:-
In Forward P/E ratio is taken for estimating earnings during next
4 quarters. Forward P/E ratio is used for calculation of forecasted earnings. This provides only estimate as per current
earnings data. There are following ways to value a stock:-
(i)
Earnings:
Are measured in terms of relative price
(ii)
Cash
Flow: are generally discounted back to present value.
Advantages of Knowing
P/E ratio
(i)
P/E
ratio indicates that if an investor invests in a company after which investor
will receive one Rs of that company’s earning. P/E ratio also indicates how
much investors are willing to pay per dollar of earnings e.g. if any company
has P/E ratio of 50. Then it means those investors will willing to pay 50 Rs
for 1 rs earning.
(ii)
Lower
P/E ratio indicates either company may be undervalued or company is doing
exceptionally well with respect to its past trends. If there are neither any
earnings nor is posting losses then P/E is expressed as “N/A”. There are sometime P/E may also be negative.
(iii)
P/E
ratio is used of standardizing the value of 1 Rs earing of earnings throughout
stock market. By taking median of P/E ratios over several years one can get
standardization of P/E ratio. This will help out in selecting a particular
stock whether stock is worth buying or not.
Limitations
of Price-Earnings Ratio
Investors
in stock market generally believe that P/E ratio is only parameter which is
needed to be considered while buying a stock. They generally believe that this
parameter gives complete insight to a stock. There are few limitations of P/E
ratio, these are as below:-
(i)
When we
compare P/E ratios of different companies of different sectors. As company
valuation and growth rates of company vary across different sectors. So P/E
ratio are considered while selecting a stock from stocks of same segment. For example
there P/E ratios of FMCG sector can’t be compared with energy sector. There may
be higher P/E ratios associated with one energy sector company but it doesn’t means
that whole sector is having P/E ratio.
(ii)
If a company has debt then both share price and company
earnings get affected due to this debt. If we compare companies from same
sector but one is having debt but other doesn’t then P/E ratio of company with
zero debt will be higher in comparison to other company with debt. Moreover if
a company has taken debt for expansion for higher earnings then P/E ratio of
that company will be higher as this company has taken a risk to generate more
earnings. But if a company is unable to pay debt then P/E ratio of that company
will be lower.
(iii)
There is foremost limitation of P/E ratio is that formula
used for calculating P/E ratio. Since P/E ratio depend upon Share market value
of a company and earnings per share estimates. Since market will determine
share value and is reliable but earnings are represented by companies may get manipulated.
Which leads to wrong calculations of P/E ratio.
P/E Ratio some of sectors are as below:-
|
Name
|
Stocks
|
M.CAP.( Cr)
|
Dividend(%)
|
P/E
|
|
Agro Chemicals
|
12
|
81,937.55
|
0.53
|
39.28
|
|
Air Transport Service
|
3
|
44,139.44
|
1.35
|
15.93
|
|
Alcoholic Beverages
|
12
|
56,314.47
|
0.24
|
23.80
|
|
Auto Ancillaries
|
67
|
256,100.77
|
0.65
|
29.12
|
|
Automobile
|
17
|
702,591.88
|
0.72
|
20.59
|
|
Banks
|
39
|
1,510,518.43
|
0.62
|
12.29
|
|
Bearings
|
1
|
77.84
|
0.00
|
0.00
|
|
Cables
|
14
|
19,680.01
|
0.43
|
14.98
|
|
Capital Goods - Electrical Equipment
|
46
|
229,819.19
|
0.36
|
24.04
|
|
Capital Goods-Non Electrical Equipment
|
46
|
98,811.93
|
0.82
|
41.86
|