Wednesday, November 19, 2008

Share Analysing Tools: P/E Ratio

How do you use P/E ratios? If you are looking to buy shares then consideration of the current P/E is relevant for you and should be a useful tool to aid in the decision. If you already hold shares in the counter, then the relevant P/E is the one you bought the shares at.

Firstly P/E stands for price earnings ratio and is calculated as

current share price divided by either
the most recent annual earnings per share

forward/estimated earnings per share based on the most recent interim or quarter numbers as per these.

More importantly, a P/E is the premium (fee) you put on a company's earning growth potential. The only other corporate action that should concern you as a shareholder where P/E is concerned would be dilutive moves such as rights issues (which you are unable to participate in) or even the kind of preferred share deals that the likes of Barclays and GS have been doing.

If my average P/E on KCB is 14, it says that I think that all things being equal, I expect KCB's share price to rise to 14 times the price I bought at over my investing horizon. Thinking about that for a minute. It implies that KCB has to in effect double its earnings for 7 years consecutively.

2ndly, P/E also tells you how much goodwill/hype the share has generated from fellow investors in the market. This is an intangible reputational element in the shareprice that can change overnight. And that is why some rank P/E low among their share analysis tools.

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