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.


Conclusion

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
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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?