Sunday, January 17, 2010

Fundamental Analysis: Price to Earning Ratio (PE Ratio)

Price to Earning ratio is commonly known as PE ratio. PE ratio is a very commonly used ratio to find some good deal in the market and to spot the under-priced stocks. PE ratio can be calculated using Price per share and Earning Per Share (EPS). By referring to PE ratio, you actually know how long would it takes to recoup your money. If you are unsure what it means "how long would it takes to recoup your money", then read on to learn about it.

The formula to calculate PE ratio is as below:

PE Ratio = Price Per Share / EPS

I have included 2 examples to share with you the calculation of Price to Earning ratio (PE ratio).

Example 1: A company stock, ABC is currently selling at RM 5.00 per share and its EPS over the past year was RM 1.00. So, in this example, we can calculate PE ratio as below:

PE ratio = 5.00/1.00 = 5

This means that if you invest RM 5000 in this stock, you will need 5 years to recoup your investment because the company is making Earning Per Share (EPS) RM 1000 per year.

Let's move on to the next example. I hope that you are can understand PE ratio with the example given.

Example 2: Another stock DEF is currently selling at RM 20.00 per share and it has a EPS ratio of RM 10.00 per year. So, in this case, the PE ratio can be calculated as:

PE ratio = RM20.00 / RM10.00 = 2

So, from this, we can see that for we only need 2 years to recoup our money invested in stock DEF. This means DEF is a better investment choice as compared to stock ABC.

In other word, the lower the PE ratio, the more attractive the stock is. Normally, we will compare the PE ratio of the stocks in the same industry. For example, we compare PE ratio of MAYBANK with CIMB, CIMB with AMMB, MAYBANK with AMMB and so on because they are all from Finance sector.

You can easily obtained the PE ratio from the newspaper in the "Business" section of the newspaper. You can compare PE ratio among different stocks to find the best deal for your investment.

If you are looking for the latest PE ratio, you can use the date from the latest Annual Report of companies and calculate the PE ratio yourself or else, you can login to you trading account to find out more.

Low PE ratio is crucial because stocks with low PE ratio is more resilient towards market crashes and buying low PE ratio stocks means you are buying low priced stocks.

Fundamental analysis is important to identify good stocks in the market. Happy Investing!!!

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