• What is the P/E ratio and what are its types?
• What is the P/E ratio of the group and what is its use?
• How is P/E used in stock analysis?

What is the concept of P/E ratio?

The P/E ratio, which stands for Price/EPS, is one of the most widely used concepts in reading charts. The word “price” means price and the word “EPS” means profit per share. The P/E ratio is also known as the price-to-earnings ratio.

The P/E ratio actually shows investors’ expectations of a stock’s future returns. This means that an investor is willing to pay how many Rials for n Rials of return he is going to get. For detailed and basic learning of this topic, we suggest you to participate in the fundamental analysis course of the Rahevard Academy.

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An example of the P/E ratio in the stock market

Suppose a company currently has a price of 400 Tomans and its EPS or profit for the current year is equal to 80 Tomans.  To calculate  the P/E of this company, we divide the daily stock price of that company by its profit:    5   =  80/400 .

Here, the P/E ratio of 5 means that stock market investors are willing to pay 5 Rials for every 1 Rial of profit that this company has.

Another interpretation for P/E is that if P/E is equal to 5, it will take 5 years for your capital to return to you through earned returns.

Types of P/E ratio

There are three types of P/E ratios that differ in the type of interest used in the denominator:

1.  Trailing P/E

The most common method of calculating the P/E ratio is the trailing P/E, which is obtained by dividing the daily price of the stock by the realized EPS of the last 12 months of the stock. The trailing P/E shows the stock’s history and is not used to predict the stock’s future.

◊  Be sure to read this article:   What is EPS?

2.  Estimated P/E

The P/E ratio is an estimate of the daily stock price divided by the forecasted EPS, also known as the forecast P/E, and is used for company future analysis and stock valuation.

3.  Average P/E

The average P/E ratio is obtained by dividing the stock’s daily price by the average realized profit of the last 6 months and the expected EPS of the stock for the next 6 months, and the analyst uses this ratio to analyze both the past and the future of the stock.

How to view the P/E of companies in Rehvard

To view and check the P/E of companies active in the stock market and decide on the value of those companies’ shares, after visiting the Rahvard site, type the name of the symbol you want in the search box. Now on the relevant icon page, P/E ratio and TTM P/E in DPS and EPS boxes respectively

What is the group’s P/E ? 

Comparing companies in an industry is one of the methods of analyzing company stocks. Group P/E refers to the average P/E ratio among companies belonging to a specific industry. P/E is one of the best ways to compare different listed companies in a group. It should be noted that the P/E of the group is different among listed and non-listed companies of the same industry.

By comparing the P/E ratio of peer companies, it is possible to find stocks of companies that are left behind in their industry and are considered buying opportunities. If the P/E of a company is lower than the average P/E of the industry, it will be possible to grow that share until it reaches the P/E of the industry. Therefore, considering P/E ratio, group P/E ratio and calculating share value is one of the first steps before stock trading. But buying shares based solely on P/E is wrong.

◊  Be sure to read this article:  What is DPS?

Appropriate P/E to buy a share

The best P/E ratio for buying shares is P/E below 10, and the lower this ratio is in a share, the better. If the P/E of a share is below 5, it is much better and this share is considered a fundamental share.

A high P/E ratio indicates that the share price is high compared to its earnings and the share is trading above its intrinsic value.

A low P/E ratio indicates that the share price is low relative to its earnings and that the share is trading below its intrinsic value.

When we choose a company with a balanced P/E, we reasonably expect the company’s growth and development in the future, and we are likely to reach our desired profit. On the other hand, we can make it more likely that even when the whole market is down and negative, our stock will have a much smaller drop in price; Compared to a company with a high P/E.

Is a high or low P/E ratio better?

Companies with low P/E ratios are often considered value stocks. In the sense that they are trading below their intrinsic value. This low price makes investors to be encouraged to buy it. Companies with a high P/E ratio are also considered growth companies. This high ratio shows that the company will have positive growth and performance in the future.

But a high P/E ratio has a disadvantage, which is that growing stocks often  have high volatility, and this puts a lot of pressure on companies; Because they have to justify their high valuation. For this reason, investing in stocks with higher growth is considered a risky investment.

Therefore, after calculating the P/E ratio of a company, it is better to research the future plans of that company and the possibility of its growth and development in order to make the best decision about investing in that company.

◊  Be sure to read this article:   What are the differences between EPS and DPS?

 Is the P/E  ratio of a company alone enough to analyze the company’s valuation?

The P/E ratio of a company cannot be interpreted alone and it should be compared with the P/E of the group in which it is located. Usually, the P/E of a company moves towards the P/E of its group. The P/E ratio is a suitable tool for valuing a stock company, but it is not enough to analyze companies alone. It is better to use more tools in addition to using this ratio to buy stocks.

What is forward P/E  and how is it calculated?

Usually, the P/E ratio is calculated after the publication of quarterly reports, which is called trailing P/E. If earnings per share for the past 12 months are used to calculate earnings per share, it is called trailing P/E or TTM. Also, if the 12-month forecast profit is used to calculate this ratio, it is called forward P/E.

One of the complicated ways to calculate P/E is to calculate it in the forward method. Because in addition to the share price and profit per share, inflation rate, bank interest rate, profit growth rate should also be considered and included in the calculations. Since the P/E ratio is one of the valuation methods, after calculating the mentioned factors, it is multiplied by the expected profit ratio and the value of the company is calculated.

◊  Be sure to read this article:  What is fundamental analysis?

The application of P/E in the analysis of a stock

P/E ratio can be used to determine the value of a company’s stock. In this way, if the price obtained by using the P/E ratio of the share is higher than the price of the share board, the share is valuable, otherwise, the share is expensive and its price may drop in the future.

To calculate the share value, you can multiply the P/E and EPS forecast for the company to get the share value:

Share value = P/E * EPS

Also, the P/E ratio shows the profitability of the company in the future. The growth of a company means more profitability. If a company’s P/E is much higher than the average of its market or industry, it means that the market’s expectations for this stock are high in the future and shareholders expect high returns. If these expectations are not met, there is a possibility of a big fall in the share price.

The P/E ratio can also be used to compare and analyze the stocks of companies in the same industry. By comparing the P/E ratio of peer companies, it is possible to find stocks of companies that are left behind in their industry, which is considered a buying opportunity. If the P/E of the company is lower than the average P/E of the industry, it is possible for the share to grow until it reaches the P/E of the industry.

Conclusion

P/E ratio can be used to determine the value of a company’s stock. If a company’s P/E is much higher than the average P/E of that company’s industry, it means that shareholders expect high returns from that stock, and if these expectations are not met, there is a possibility of a large fall in the share price. To learn more about this concept, we suggest you read the fundamental analysis training article.