What is P/E?  The significance of the P/E ratio in the financial sector

What is P/E? The significance of the P/E ratio in the financial sector

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What is P/E?? In the field of finance – securities, P/E is one of the basic indicators used to price stocks. The following article Makemoney will help you understand this type of indicator!

What is P/E? Formula to calculate P/E

The “Price to Earning ratio” or P/E is an indicator used to gauge the relationship between “Price” (the market price of a stock) and “EPS” (earnings per share).

“Price to Earning ratio” or P/E

The P/E ratio is calculated using the following formula:

P/E = Price/EPS. In which EPS is calculated according to the formula: EPS = (Earnings after tax – preferred stock dividends)/total outstanding shares.

Take an example to better visualize such as:

For example, if the share price of FLC on the stock market is VND 100,000 and the earnings per share is VND 5,000, then the P/E ratio will be calculated as 100,000/5,000 = 20. That means the investor will have to pay 20 VND for every 1 VND profit FLC earns in a year.

If the P/E Ratio drops to 10, it means that the investor only pays 10 VND for every 1 VND of profit.

At this point, if the P/E ratio drops much, it means that investors need to pay that much for every dollar of profit. In short, P/E will be the number of years to break even in the case of constant profits.

This index is calculated on the basis of taking data for 1 year (4 consecutive quarters). P/E ratios include two types and investors need to distinguish between the two. One is the trailing P/E type (earning the previous 4 quarter earnings) and the forward P/E type (the next 4 quarter earnings forecast). However, when simply referring to the P/E ratio, it should be understood that it is a type of trailing P/E.

What does P/E mean in the field of stock investment?

So what is the meaning of the P/E ratio?

Through the P/E index, investors will know the specific price they need to pay for a dollar of profit earned from a stock.

When P/E ratios are low, they allow us to understand the stock is undervalued

When P/E ratios are low, they allow us to understand that the stock is undervalued, the business that owns the stock is facing some difficulties or problems with communication, business, finance, etc. On the other hand, a low P/E also shows that the business is experiencing sudden profits due to some reason, such as selling assets. At the same time, the business is at the peak of a business cycle.

Conversely, when P/E ratios are high, they allow investors to understand that the stock is overvalued. It means that the business has great development prospects in the future, although the profit may not be high, but it is only temporary. Similarly, a high P/E ratio indicates that a business is at the bottom of a business cycle.

So how does the P/E ratio perform well?

After understanding what P/E is and what it means, investors should pay attention to their effects. Of course, the effect of P/E only comes into play when they are under the same conditions and circumstances. The volatility of the P/E ratio is often affected by factors such as:

– Growth

– Competitive advantage

– Level of financial risk

– Business areas

– Macro conditions such as interest rates, inflation, GDP of the country….

P/E only works when they are under the same conditions and circumstances

The lower the P/E ratio, the better if financial, business or macro conditions are the same. In fact, it is quite difficult to judge how good this particular type of indicator is. However, if investors pay much attention to this index, some points can be noted as follows:

– Is the growth rate of the business fast? If the growth is less than 10% and the P/E ratio is still very high, it shows that the company’s shares are overvalued.

– What is the general P/E ratio of the business sector? It is not feasible to compare the P/E ratio of a high-tech enterprise and an agricultural product processing and manufacturing enterprise.

– How are the macro conditions such as interest rates and inflation? Usually P/E will be inversely proportional to these two factors.

– The level of risk of the company such as financial risk (debt) or business risk (HR, ability to enter the industry, sales management, …)

And finally, is this a cyclical business?

However, if only regularly interested in P/E ratios, investors should only consider companies with P/E ratios less than 1/bank interest rates. For example, if the bank interest rate is 7%, then P/E < 14.3. Investors can drop to a lower level to be safe.

An average P/E between 5 and 12 is normal. When an investor buys a stock with a high P/E ratio in the current economic conditions of his home country, the P/E > 15 should make sure it’s a good business, or the investor can rely on another method. for stock valuation.

Usually, the risk of a high P/E ratio is higher than that of a low P/E ratio.

Some notes about the P/E . ratio

What is the P/E ratio? It is a simple metric and not difficult to calculate. They are also considered as a tool to help investors effectively price in the stock market. However, when using P/E, there are a few things to keep in mind:

– Earnings per share can be negative and at this point the P/E ratio has no meaning. Investors should rely on other tools to value stocks.

– Profit is a volatile factor, so the P/E ratio can also be prone to fluctuations. Therefore, investors should look at P/E over a long period of 3-5 years.

Hopefully the information shared above will help you better understand what P/E is as well as how they are calculated and what they mean! If you have a need to invest in stocks, please call immediately Makemoney via hotline 0944.31.9963 for advice.

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