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Price earnings ratio (P/E ratio) |
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Price earnings ratio (P/E ratio)P/E = current share price of a company divided by its earnings per shareA company with a share price of 100p and earnings per share (EPS) of 5p has a P/E ratio of 100/5 = 20.A company's P/E (also known as its multiple) shows how high its shares are priced in relation to its historical earnings. Although mathematically, it relates share price to past performance, the reality is that P/Es are more about forward expectations than the past. A high P/E indicates that the City expects the company's earnings to grow fast in the future.P/E 're-ratings' by the City can have a dramatic effect on share price. If a company regarded as a growth stock announces sharply reduced trading figures, fund managers may revise their view of the company, and decide that it doesn't justify a growth stock P/E of 20, and can only justify a more normal P/E of, say 12. If earnings were 10p share, that re-rating would suggest a change in share price from 200p to 120p.Equally, if a company announces some major technical breakthrough, or a major contract, the City may decide that its future earnings potential justifies a growth P/E, and re-rate it upwards from 12 to 20 (or equivalent figures). In which case the share price will leap.There is nothing formal about this re-rating procedure. It is simply buyers in the market pushing up the price to reflect a new perception of a company. But P/Es do tend to be comparative, in that companies in the same sector with similar prospects would normally have similar P/Es. If they don't, there is invariably a reason accounting for the difference.Similar MatchesPrice earnings growth factorPrice earnings growth factorThe PEG of a company is calculated by dividing its prospective P/E ratio by the estimated future growth rate in earnings per share of the company. So to calculate a PEG, you first need to calculate its P/E ratio.P/E = current share price divided by earnings per shareA company with a share price of 100p and earnings per share of 5p has a P/E ratio of 100/5 = 20.By itself the P/E ratio is a useful ratio because it shows how many times the current earnings the shares cost - in a sense, how many years you would have to wait to get your money back if the company paid out all its earnings to shareholders. But the limitation of the P/E ratio is that it looks at historical information and does not relate the price of the shares to its future performance. The PEG ratio builds in that extra layer of sophistication.Using the example of the same company, imagine that the consensus brokers' forecast for its future earnings growth rate is 15%.PEG = P/E divided by estimated future growth rateFor this company, the PEG would be 20 divided by 15 = 1.33.According to Jim Slater, the investor who popularised the use of PEG's as a stock share selection tool, a share with a PEG of 1 or lower is attractive. Put simply, the lower the PEG, the less you are being asked to pay for estimated future earnings. Jim Slater did not recommend use of the PEG as the only criteria of share selection. There are plenty of other fundamental checks that have to be made too.Note that the estimated future earnings are a critical part of the PEG calculation, and that if the forecasts made by brokers are wide of the mark, the PEG ratio will be unreliable. Because of this danger, most advocated of PEG's recommend using consensus forecasts, rather than the forecasts of any single broker/analyst. Fully diluted earnings per sharesFully diluted earnings per sharesEarnings per share expressed as if all outstanding convertible securities and warrants have been exercised. State Earnings Related Pension SchemeState Earnings Related Pension SchemeA government scheme introduced in April 1978 which enables employees (but not the self-employed) to top up the basic pension they receive on retirement with additional pension payments based on their earnings.Employees make payments to SERPS by way of Class 1 National Insurance (NI) contributions. They can 'contract out' of SERPS and pay Class 1 contributions via a rebate which may be invested in an occupational pension or a personal pension plan.SERPS was replaced in April 2002 with the 'State Second Pension' which is designed to give more to the lower paid and middle earners, carers and the long-term disabled with broken work records. Whereas with SERPS, the more you earn, the higher your pension, S2P operate a flat rate which means that high earners will be better off opting for private pension schemes. Earnings before taxes (EBT)Earnings before taxes (EBT)A financial measure defined as revenues less cost of goods sold and selling, general, and administrative expenses. In other words, operating and nonoperating profit before the deduction of income taxes. Lower earnings limitLower earnings limitThe level of income at which employees start to pay Class 1 National Insurance contributions. Further SuggestionsPrimary earnings per (common) shareband earnings retained earnings normalised earnings earnings yield earnings per share taxable earnings net relevant earnings Earnings momentum Earnings before interest after taxes (EBIAT) Quality of earnings earnings cap Earnings before interest, taxes, and depreciation (EBITD) adjusted earnings Normalized earnings Earnings before interest and, taxes (EBIT) upper earnings level Earnings Earnings retention ratio earnings earnings factor Pretax earnings or profits Earnings price ratio Earnings response coefficient Retained earnings |
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