P/E ratios and fair value

gwaipor · 26 March 2015

Need some clarification on analysing whether a stock is too expensive for current PE ratio

Example:
Current PE: 60
Current price of stock: $2
EPS current: $0.02

Here is where I started dabbling - please correct if I'm wrong
Price to be neutral: Current PE * EPS current = $1.20

Question: Does that mean that if stock drops to $1.20, then it would be fair value (neither bargain nor too expensive to buy)

galumay · 26 March 2015

gwaipor said:
Need some clarification on analysing whether a stock is too expensive for current PE ratio

Example:
Current PE: 60
Current price of stock: $2
EPS current: $0.02

Here is where I started dabbling - please correct if I'm wrong
Price to be neutral: Current PE * EPS current = $1.20

Question: Does that mean that if stock drops to $1.20, then it would be fair value (neither bargain nor too expensive to buy)

If the price is $2 and the EPS 2c then the P/E is 100. While P/E is a poor metric for value, obviously it's price is relatively high or its earnings relatively low for a ratio like that.

Using P/E as a sole metric to measure value is unreliable at best.

skc · 26 March 2015

gwaipor said:
Need some clarification on analysing whether a stock is too expensive for current PE ratio

Example:
Current PE: 60
Current price of stock: $2
EPS current: $0.02

Here is where I started dabbling - please correct if I'm wrong
Price to be neutral: Current PE * EPS current = $1.20

Question: Does that mean that if stock drops to $1.20, then it would be fair value (neither bargain nor too expensive to buy)

PE is not a number that exists independently. It's a calculation of share price dividend by EPS. So in your example, the PE = $2/$0.02 = 100. The number "60" for current PE is incorrect.

As to your question... there is no single answer for what is a fair PE. It depends on all sorts of factors like growth, interest rates, where industry peers are trading, capital structure etc etc.

PE is a useful number but not a be all, end all figure.

gwaipor · 26 March 2015

Thanks for the replies
I ask because when I look in Commsec, I see PE, Price, and EPS
But they don't match

Example CSL
PE 26.55
Price as of today $92.09
EPS $2.857

Is it because the EPS I'm looking at is from the last report 2014 and not current? (I'm looking at the Forecast & Trends tab)

Hodgie · 27 March 2015

gwaipor said:
Thanks for the replies
I ask because when I look in Commsec, I see PE, Price, and EPS
But they don't match

Example CSL
PE 26.55
Price as of today $92.09
EPS $2.857

Is it because the EPS I'm looking at is from the last report 2014 and not current? (I'm looking at the Forecast & Trends tab)

I wouldn't put too much faith in some of the information such as ratio's on Commsec. you are better off just using the raw data and completing your own calcs.

galumay · 27 March 2015

Hodgie said:
I wouldn't put too much faith in some of the information such as ratio's on Commsec. you are better off just using the raw data and completing your own calcs.

Agree 100%, i have given up on trusting any info on Commsec, I discovered its nearly always different to what you find/calculate from the actual annual reports.

luutzu · 27 March 2015

gwaipor said:
Thanks for the replies
I ask because when I look in Commsec, I see PE, Price, and EPS
But they don't match

Example CSL
PE 26.55
Price as of today $92.09
EPS $2.857

Is it because the EPS I'm looking at is from the last report 2014 and not current? (I'm looking at the Forecast & Trends tab)

from memory, AspectHuntley used to provide these data to Commsec. MorningStar bought it off and continue for a while without much changes... if they are still using AspectHuntley's definition then the PE ratio uses what they call "projected" future EPS - a combination of the average consensus forecast earnings and the last reported earnings, something like that.

But yes, careful in using other people's data. Could be error or could be outdated.

I relied on them before and the number of share outstanding was old... I checked the announcements but the news release available there didn't indicate any dilution so assumed it's a close approximate. Only after I bought that i found out, from the annual report, the company raised a bunch of equity a couple weeks after the last report - diluting the stocks twice over.

-----

gwaipor · 31 March 2015

Followup question...please correct if wrong I'm still new

A fair PE is when PE = growth rate % of the EPS
So if an announcement says EPS increased 18%, then a fair PE is 18x, and hence you can calculate the fair price to buy in? (Excluding all other considerations you need to have for purchasing a stock)

galumay · 31 March 2015

gwaipor said:
Followup question...please correct if wrong I'm still new

A fair PE is when PE = growth rate % of the EPS
So if an announcement says EPS increased 18%, then a fair PE is 18x, and hence you can calculate the fair price to buy in? (Excluding all other considerations you need to have for purchasing a stock)

No, P/E is what it is, the ratio of price to earnings. There are different methods, straightforward is reported earnings to price, forward P/E looks at the projected earnings instead.

Just because EPS increased 18% doesnt mean a fair PE is 18. Its really not a valuation metric you can use on its own. Its sometimes useful in a comparitive sense, for a filter, and in very general terms a company with stronger growth will trade at a higher relative PE to others in the same sector. EPS figures can be distorted which impacts PE and there may be other drivers than EPS growth that input to the price. (takeover potential, capital raising, etc.)

I dont believe you can ever use PE alone to calculate a "fair price to buy in".

stevealimore · 25 April 2015

gwaipor said:
Followup question...please correct if wrong I'm still new

A fair PE is when PE = growth rate % of the EPS
So if an announcement says EPS increased 18%, then a fair PE is 18x, and hence you can calculate the fair price to buy in? (Excluding all other considerations you need to have for purchasing a stock)

What you are referring to is known as PEG, which is PE ratio divided by the growth rate.

Small and fast growing companies tend to command a premium, and PEG is one of many usual indicators. PEG of less than one is bargain, PEG of 1 is fair and PEG greater than 1 is expensive.

Although useful, but it should not be the only metric to use when evaluating a company.

P/E ratios and fair value

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P/E ratios and fair value

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