Stock Valuation: P/E Ratio

What is P/E ratio?
Price-to-earnings ratio, or commonly known as the P/E ratio, is a standard tool for valuing stocks. It is computed by dividing the market price per share of stock by the company's current earnings per share (EPS). When we buy shares of common stock, we become a stockholder of the company. As a stockholder, we have a proportionate share in the company's earnings. The P/E ratio is the price that we are willing to pay for the company's earnings. If the company is trading at a multiple (P/E) of 20, the investor is willing to pay an amount of 20 for 1 of current earnings. The more profit the company makes, the more attractive it is to the investors. The market's perception about a company's future earnings drives the stock's price and so its P/E ratio.

How are P/E ratios used?
The P/E ratios are best used by comparing companies with a high P/E and a low P/E in the same sector. High P/E means high expectations of the company's future earnings. A very high P/E can mean that the company is overpriced or 'expensive' and any negative development on its prospects may lead to falling P/Es. The higher the P/E, the harder the fall, and the greater the risk to the investor. On the other hand, low P/E means the expectations on future earnings of the company are low. Unusually low P/E may indicate a weak company with poor prospects for growth. To some degree, either high or low P/E can expose an investor to risk.

The basic rule is to look for companies that are selling at relatively low P/Es but have high expectations of earnings growth. Some traders make a shortlist of stocks based on this and apply technical indicators to determine the trade entry and exit points.

Where to find a company P/E ratio ?
There are many sources for P/E ratios and these include company website, online stockbroker, stock exchange website, online and paper publication, and market data provider like Bloomberg or Reuters.
Here's a report that includes the P/E ratios (PER) of some listed companies in the Philippine Stock Exchange. It's a free online publication that can be downloaded from the PSE website.