The PEG multiple takes the P/E analysis to the next stage. Since P/E ratios are computed based on historic earnings, they project an inaccurate picture of the future. The PEG multiple uses expected growth in earnings, to give investors additional information.
The PEG divides the historical P/E ratio by the compounded annual growth rate of future earnings. Generally, the compounded earnings growth is calculated using the forecasted earnings for the next two-three years.
For example, if a company is quoting at a P/E of 60 based on historic earnings and the compounded annual growth rate of its earnings for the next three years is 20 per cent, then its PEG is 3.
The lower the PEG, the more attractive the stock becomes as an investment proposition. It is obviously more appealing to buy a stock on a P/E of 20 whose earnings are growing at 50 per cent than to buy a stock on a multiple of 50 whose earnings are growing at 20 per cent.
As a thumb rule, stocks quoting at a PEG multiple below 0.5 are considered to be undervalued, 1 to be fairly valued, and 2 to be overvalued.
Monday, November 26, 2007
How is a P/E multiple used?
Is a stock trading at a P/E of 30 more expensive than a stock trading at a P/E of 60? Such a wide variation in P/E multiples can be owing to a few reasons. If the companies are in the same industry, it could be that the company with a high P/E may be one with superior size and financials, with better prospects or even better management. The market expects this stock to outperform its peers. If they are from different industries, it could also be due to different growth prospects. For example, an energy utility will have a more sedate earnings profile than say a software company.
Stock prices, in isolation do not give any indication whether the stock is undervalued or overvalued. They have to be viewed along with the company's future prospects to arrive at any conclusion. Generally, higher the expected growth in a company's earnings, higher is the P/E multiple that it attracts in the market. The time period used for P/E calculations depends on the investment horizon of the investor and would be different for each investor. However, P/E multiples cannot be applied to loss making companies since they do not have any earnings.
Stock prices, in isolation do not give any indication whether the stock is undervalued or overvalued. They have to be viewed along with the company's future prospects to arrive at any conclusion. Generally, higher the expected growth in a company's earnings, higher is the P/E multiple that it attracts in the market. The time period used for P/E calculations depends on the investment horizon of the investor and would be different for each investor. However, P/E multiples cannot be applied to loss making companies since they do not have any earnings.
What is a P/E multiple?
The P/E multiple is the premium that the market is willing to pay on the earnings per share of a company, based on its future growth.
The ratio is most often used to conclude whether a stock is undervalued or overvalued.
The P/E is calculated by dividing the current market price of a company's stock by the last reported full-year earnings per share (EPS).The P/E thus computed is also known as the trailing or historical P/E since it uses the trailing (historical) EPS in its calculations.
With the advent of quarterly results, it is also possible to compute P/E, based on the earnings of the latest four quarters’ EPS. This is known as trailing twelve months P/E.
A variant of the P/E - called the forward P/E - has also been developed wherein the current market price of the stock is divided by the expected future EPS. The attempt to study P/E ratios in this manner reflects the effort to factor in the expected growth of a company.
For an investor it makes much more sense to look at the forward P/E for taking an investment decision.
The ratio is most often used to conclude whether a stock is undervalued or overvalued.
The P/E is calculated by dividing the current market price of a company's stock by the last reported full-year earnings per share (EPS).The P/E thus computed is also known as the trailing or historical P/E since it uses the trailing (historical) EPS in its calculations.
With the advent of quarterly results, it is also possible to compute P/E, based on the earnings of the latest four quarters’ EPS. This is known as trailing twelve months P/E.
A variant of the P/E - called the forward P/E - has also been developed wherein the current market price of the stock is divided by the expected future EPS. The attempt to study P/E ratios in this manner reflects the effort to factor in the expected growth of a company.
For an investor it makes much more sense to look at the forward P/E for taking an investment decision.
Friday, August 24, 2007
What is Earnings Per Share (EPS) ?
Earnings is the net income or net profit made by a company.This is the first and most important factor in analyzing a company for large groups of investors.
Earnings Per Share (EPS) is the total profit made by a company divided by the number of outstanding shares of that company.
You calculate the EPS by dividing the 12 month earnings or profit of a comapny for any financial year by the number of shares it currently has outstanding.
Thus, if company ABC Ltd. has 1 lakh shares outstanding and has earned Rs.50 lakhs in financial year 2006-2007, it has an EPS of Rs.50.
Rs.5000000
--------------- = Rs. 50 in Earnings Per Share (EPS)
100000 shares
Earnings Per Share (EPS) is the total profit made by a company divided by the number of outstanding shares of that company.
You calculate the EPS by dividing the 12 month earnings or profit of a comapny for any financial year by the number of shares it currently has outstanding.
Thus, if company ABC Ltd. has 1 lakh shares outstanding and has earned Rs.50 lakhs in financial year 2006-2007, it has an EPS of Rs.50.
Rs.5000000
--------------- = Rs. 50 in Earnings Per Share (EPS)
100000 shares
Saturday, February 3, 2007
Why do stock prices fluctuate so much?
Stock prices fluctuate because they are determined purely by supply and demand.
For any stock, you will always have a large number of buyers and sellers.
Depending on the expectations and mood of these buyers and sellers, sometimes the demand for shares from buyers is stronger than the supply of shares from sellers, resulting in a price rise.
Similarly, if the supply from sellers exceeds the demand from buyers;prices will fall.
For any stock, you will always have a large number of buyers and sellers.
Depending on the expectations and mood of these buyers and sellers, sometimes the demand for shares from buyers is stronger than the supply of shares from sellers, resulting in a price rise.
Similarly, if the supply from sellers exceeds the demand from buyers;prices will fall.
Thursday, January 18, 2007
Tax on profits made in shares
There is no tax on dividend.
When you sell any asset you own (house, land, shares, mutual fund units, gold, debentures, bonds), and you make a profit on the sale, it is known as capital gain.
If you sell your shares after a year, the profit you make is referred to as long-term capital gain. There is no tax on long-term capital gain.
If you sell it within a year of buying, it is referred to as short-term capital gain and taxed at 10% of the profit made.
When you sell any asset you own (house, land, shares, mutual fund units, gold, debentures, bonds), and you make a profit on the sale, it is known as capital gain.
If you sell your shares after a year, the profit you make is referred to as long-term capital gain. There is no tax on long-term capital gain.
If you sell it within a year of buying, it is referred to as short-term capital gain and taxed at 10% of the profit made.
How shares reward an investor?
If you are a shareholder you can benefit in two ways : capital appreciation and divedend.
Dividend
Usually, a company distributes part of the profit it earns as dividend.
Say a company earned a profit of Rs 1 crore (Rs 10 million) in 2005-06.
It keeps half that amount within the company. This is used for a variety of purposes -- buying more machinery, land or raw materials, building a new factory or setting up a new office. It could even be used to repay loans.
The other half is to be distributed as dividend.
Assume the company has 100000 shares. This would mean half the profit -- ie Rs 50 lakh (Rs 5 million) -- would be divided by 100000 shares.
So each share would earn Rs 50. The dividend would then be Rs 50 per share.
If you own 100 shares of the company, you get a cheque of Rs 5000 (100 shares x Rs 50) from the company.
Capital Appreciation
When the company issues shares, it gives a basic value to each share -- say Rs 10. This is called the face value of the share.
When the share is traded at the stock market, however, this value may go up or down, depending on the supply and demand for the stock.
The value of a share in the market at any point of time is called the price of the share or the market value of a stock.
A share with a face value of Rs 10, may be quoted at Rs 100 (higher than the face value), or even Rs 5 (lower than the face value).
If you buy a stock for Rs 10 and sell it for Rs 20 after a year, your return from that stock is Rs 10, or 100%.
Or if you buy a stock for Rs 10 and sell it for Rs 9, you lose Re 1, or your loss is 10%.
Dividend
Usually, a company distributes part of the profit it earns as dividend.
Say a company earned a profit of Rs 1 crore (Rs 10 million) in 2005-06.
It keeps half that amount within the company. This is used for a variety of purposes -- buying more machinery, land or raw materials, building a new factory or setting up a new office. It could even be used to repay loans.
The other half is to be distributed as dividend.
Assume the company has 100000 shares. This would mean half the profit -- ie Rs 50 lakh (Rs 5 million) -- would be divided by 100000 shares.
So each share would earn Rs 50. The dividend would then be Rs 50 per share.
If you own 100 shares of the company, you get a cheque of Rs 5000 (100 shares x Rs 50) from the company.
Capital Appreciation
When the company issues shares, it gives a basic value to each share -- say Rs 10. This is called the face value of the share.
When the share is traded at the stock market, however, this value may go up or down, depending on the supply and demand for the stock.
The value of a share in the market at any point of time is called the price of the share or the market value of a stock.
A share with a face value of Rs 10, may be quoted at Rs 100 (higher than the face value), or even Rs 5 (lower than the face value).
If you buy a stock for Rs 10 and sell it for Rs 20 after a year, your return from that stock is Rs 10, or 100%.
Or if you buy a stock for Rs 10 and sell it for Rs 9, you lose Re 1, or your loss is 10%.
Saturday, January 13, 2007
Fundamental versus Technical Analysis of Shares
Fundamental stock analysis requires, among other things, a close examination of the financial statements for the company to determine its current financial strength, future growth and profitability prospects, and current management skills, in order to estimate whether the stock's price is undervalued or overvalued.
Technical analysis is the evaluation of shares by means of studying statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security's intrinsic value but instead use stock charts to identify patterns and trends that may suggest what a stock will do in the future.
In the world of stock analysis, fundamental and technical analysis are on completely opposite sides of the spectrum. Earnings, expenses, assets and liabilities are all important characteristics to fundamental analysts, whereas technical analysts could not care less about these numbers. Which strategy works best is always debated.I personally analyse shares using a mix of fundamental and technical analysis.
Technical analysis is the evaluation of shares by means of studying statistics generated by market activity, such as past prices and volume. Technical analysts do not attempt to measure a security's intrinsic value but instead use stock charts to identify patterns and trends that may suggest what a stock will do in the future.
In the world of stock analysis, fundamental and technical analysis are on completely opposite sides of the spectrum. Earnings, expenses, assets and liabilities are all important characteristics to fundamental analysts, whereas technical analysts could not care less about these numbers. Which strategy works best is always debated.I personally analyse shares using a mix of fundamental and technical analysis.
Monday, January 8, 2007
What are shares?
There are a number of different shares you can buy, including preference shares, bonds, and gilts but the most popular type is the ordinary share. Ordinary shares simply represent ownership of a company.
So, when you buy shares, also known as equities or stocks, you literally become a part-owner of that business.
Companies do not have to list on the stock market to issue shares. Many businesses start life with friends and family as shareholders. These businesses are called unlisted firms and their shares are often referred to as ‘unquoted’.
Once a company decides to raise money from the general public it is called a Public Limited Company (Plc) and is a ‘listed firm’. Its shares are then referred to as ‘quoted’ or ‘listed’ on the stock market.
As a shareholder you have a say in the company’s affairs by voting at company meetings and, of course, the ability to share in its fortunes. If the company does well, the value of your investment should rise but if it does badly, you could see your shares fall in value.
So, when you buy shares, also known as equities or stocks, you literally become a part-owner of that business.
Companies do not have to list on the stock market to issue shares. Many businesses start life with friends and family as shareholders. These businesses are called unlisted firms and their shares are often referred to as ‘unquoted’.
Once a company decides to raise money from the general public it is called a Public Limited Company (Plc) and is a ‘listed firm’. Its shares are then referred to as ‘quoted’ or ‘listed’ on the stock market.
As a shareholder you have a say in the company’s affairs by voting at company meetings and, of course, the ability to share in its fortunes. If the company does well, the value of your investment should rise but if it does badly, you could see your shares fall in value.
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