THUNDERLION

business SOLUTIONS

 

The importance of PE Ratios

 

First of all, what is a PE Ratio? Well simply put its the trading price per share divided by the earnings per share.

 

For example: company xyz is trading at 100 cents per share. Their last reported earnings was 8 cent per share. Therefore the PE Ratio is 12.5.

 

So why may you ask is this number important in my life? Well this in a way represents how many years it will take for you to get your money back if earnings remained the same as what it is now. Therefore the smaller the PE the quicker you will get your money back!

 

Of coarse its not always that simple. The obvious drawback to this method of valuation is that it  is based on past earnings. Things might have changed in the mean time, or there might have been special circumstances to the previous reported earnings, such as one off charges for a BEE deal for example.

 

Sometimes the PE ratio of a company will rise in anticipation of positive earnings, or be lower because of anticipated lower earnings.

 

In spite of the draw backs the PE ratio does have its use when used in conjunction with other methods. Such as comparing the PE to other company’s in the same sector to get an idea of whether your company is over or under valued to its peers.

 

The PE ratio is not a quick fix valuation method for companies, but it is definitely a useful tool when used together with valuation techniques and fundamental research.