Tuesday, October 7, 2008

Price to Earnings P/E Ratio

Price to Earnings or P/E Ratio maybe the simplest way to know the value of the Stock.

Here's how the P/E is computed.

Company ABC has a
- total shares of 1000 shares.
- Income of Php 100 annual

Earnings Per Share (EPS) may now be computed by dividing the Income / No. of Shares
In this case 100 / 1000 = 0.1 Earnings per Share.

This means that a share of a company makes PhP 0.1 per year.
EPS - shows the true value of the company.

Now P/E ratio on the other hand show how much a share of stock is valued by the investor.
If ABC company was selling for Php 1 per share
That gives it 1/0.1 = 10 P/E.

In the simplest terms, EPS may be compared to the COST-OF-PRODUCTION of a product. A cake may cost Php 100 in ingredients and labor. (Cost = EPS). The cake can now be sold for Php 200 (Price), which gives it a "sort-of" P/E ratio of (2). However, due to the demand of the cake people are willing to buy it for Php 1000 a piece, that gives it a P/E of 10.

Now since you know the value of EPS, you'll know that a particular stock is over priced. So always keep the look out for bargain stocks P/E of less than 15. But, make sure that the financial statement of the company is healthy.

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