What is a P/E ratio?
One of the primary objectives of Effi Enterprises is to help a company realize value. There can be many means through which the valuation of a company is achieved. Efraim Landa is a venture capitalist who is intent on helping emerging companies and entrepreneurs learn how to successfully manage the finances of the business. This includes helping businessmenconsider all available options including venture capital, IPO’s or strategic alliances or joint ventures. One thing that is commonly discussed among businessmen and investors it the P/E ratio.
What is the P/E Ratio?
The P/E Ratio is a proportion that can be used to learn about a company’s earnings and its value. P stands for Price, and E represents earnings. The price is relatively easy to find as it can be found through any vendor. The trading price for stocks is easily accessible through online resources. As an example, if a company’s stock is trading at $42 per share and the earnings for the last year was $1.55 per share, then the P/E ratio is found by dividing $42 by $1.55. The P/E ratio for the company’s stock would be 27.10. The earnings per share (EPS) is generally obtained by looking at the last four quarters but some prefer to take it from the estimates of what is expected over the upcoming four quarters or the projected P/E. Other companies will use the sum of the previous two quarters and the estimate of the upcoming two quarters.
What does the P/E Mean?
Generally a higher P/E will indicate to investors that they should expect an increased growth in earning in the future if it is compared to companies which have a lower P/E. But you cannot look solely at the P/E ratio. Typically, the P/E ratio is compared among companies in the same industry. It may also be compared to the overall market value or to the company’s previous ratios. It would not make any sense to compare a utility companies P/E ratio to one of a technology development company. In comparison the technology company would far surpass the utility company if based on the P/E ratio alone.
What the P/E ratio is used for is for investors to decide how much they are willing to pay per dollar of earnings. To interpret this let’s say a company is currently trading a multiple P/E at 20 which means that the investor would be willing to pay $20 for each $1 of earnings. For example’s sake we can say that Google is trading currently at $400 a share and the EPS is $13.31. That means that an investor can expect to earn $13.31 for each share that is available. But if Google only has 315 million shares which are outstanding shouldn’t they be available for $13 a share? No, simply because an investor plans on holding on to stocks for an extended amount of time, and they expect for the company’s stocks to increase in value during that time. That means that they will willingly pay a premium now hoping that they will get a higher return later. With a P/E ratio of about 30, an investor will pay 30 times more per share in Google.
The important thing for investors to note is that the P/E ratio is not the only influencer for making decisions. The P/E ratio has a higher quality based on the quality of the underlying earnings value. This is only one of the factors used to decide where to invest monies. Remember that investments are typically long term and after the initial purchase it is a game of waiting to see how much the price will increase until a profit is made.