Hello! This is Good Morning USA, your reliable investment guide. The world of stock investing can feel complex and difficult. It's easy to get lost in the countless indicators and terms. But don't worry! Today, I will explain a crucial indicator for building a solid foundation in investing: the PER (Price to Earnings Ratio). PER is one of the most fundamental tools for evaluating a company's value and can greatly assist in making wise investment decisions.
What is PER?
PER stands for "Price to Earnings Ratio," and it is the current stock price divided by the earnings per share (EPS). In simpler terms, it shows how much an investor is paying for each 1 won of profit the company earns.
It can be expressed in the following formula:
PER = Current Stock Price / Earnings Per Share (EPS)
Here, Earnings Per Share (EPS) is the company's net income (usually the sum of the past year or the last four quarters) divided by the total number of outstanding shares. In other words, it indicates how much net income was generated per share.
EPS = Net Income / Total Number of Outstanding Shares
For example, if Company A's current stock price is $100 and its earnings per share (EPS) is $5, then the company's PER is:
PER = 100 / 5 = 20
This means that an investor is paying $20 for every $1 of net income the company earns.
How Should You Interpret PER?
The PER value itself doesn't hold much meaning in isolation. PER's true value comes from relative comparisons. Generally, PER can be interpreted as follows:
Low PER:
Suggests that the current stock price may be undervalued compared to the company's earnings potential.
Can also be interpreted as the time it takes to recoup the investment being relatively short. (In the example above, a PER of 10 means it would take 10 years to recoup the investment, assuming the current profit level remains constant.)
However, a low PER isn't always good. The market might view the company's future growth prospects as low, or there might be specific risk factors.
High PER:
Could signal that the current stock price is overvalued compared to the company's earnings.
But it's not necessarily bad. It can also mean that market participants highly value the company's future growth potential and are willing to pay a high price because they expect much larger profits in the future.
High PERs are commonly observed in industries where future value is considered important, such as growth stocks with innovative technology or biotech companies.
Why is PER Important?
PER provides investors with the following important information:
Relative Valuation: By comparing a company's PER with those of competitors in the same industry, you can gauge whether the company's stock price is expensive or cheap compared to its peers.
Market Expectations: The PER level can give you insight into the market's expectations for the company's future profitability and growth.
Investment Style Determination: It serves as a reference for finding companies that match your investment style, whether you want to invest in value stocks with low PERs or growth stocks with high PERs but expected growth potential.
Important Cautions When Using PER!
PER is a very useful indicator, but it should not be blindly trusted. When interpreting and using PER, you must consider the following limitations and cautions:
Industry Characteristics: Average PER levels vary significantly by industry. High-growth technology industries tend to have much higher average PERs than traditional manufacturing industries. Therefore, comparisons must be made within the same industry to be meaningful.
Quality of Earnings: Net income, which is the basis for PER calculation, can fluctuate greatly depending on accounting methods or one-time gains/losses (such as asset sale profits). It's important to consider the "quality of earnings"—whether the profit came from sustainable business activities.
Limitations for Loss-Making Companies: Loss-making companies with negative net income cannot have a PER calculated or will have a negative value, making interpretation impossible. In such cases, other indicators like PSR (Price-to-Sales Ratio) should be used.
Limitations of Future Prediction: PER is based on past or current performance. It does not perfectly reflect future earnings growth, so additional analysis of the company's future prospects is essential.
Do Not Use in Isolation: PER is just one of many investment indicators. You should never make investment decisions based on PER alone. You must comprehensively consider various factors such as the company's financial health (debt ratio, etc.), growth potential (revenue growth rate, etc.), dividends, management competence, and market conditions.
Tips for Using PER as a Wise Investor
Compare with the average PER of the same industry.
Check the company's historical PER trend. (Determine whether the current PER is historically high or low.)
Also refer to "Forward PER" based on expected future earnings. (Can be found in brokerage reports, etc.)
Analyze comprehensively with other valuation indicators such as PBR (Price-to-Book Ratio), PSR (Price-to-Sales Ratio), and EV/EBITDA.
Conclusion
PER is a very useful basic tool for understanding the world of stock investing. If you understand the meaning, calculation method, and cautions for interpretation of PER well and use it wisely with other indicators, you can make more in-depth analyses and successful investment decisions. Investing is not a sprint but a marathon. I hope you will continue to learn and analyze to build a solid foundation for investing!
I will return with another important investment indicator next time. I wish you successful investments!
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