P/E RATIO

 

 

P/E RATIO

P/E ratio is an important factor when defining the valuation of a company/stock. The easiest way to use, is basically : the lower the better.

But it’s not that easy. Altough it’s an important parameter but by itself can’t really be used to value a stock, but when it’s used together with other metrics it can largely help to get a reliable image about the stock price of the examined company.

This equation has 2 factors. The P which is the price of one share of a specific stock and the E which is the EPS (Earnings Per Share) and not the total earnings of the company.

What is a good P/E?

The US SPY index healthy average P/E is about 15. In 2021 it’s showing signs of a massive asset bubble as the P/E is cc. 42. It’s not terrible for a growth stock but it’s insanely frightening for an index that’s tracking 500 stocks. It means that the market is carzy overvalued.

The Hang Seng Index (Hong Kong) average is also about 15. In Aug 2021 it’s about 16 so it’s definitely in a fair range. Update on Aug 21: There has been a strong sell-off recently so P/E went even lower in the Chinese Equity Markets.

It also matters what type of company and industry you examine, as different companies and different industries can differ significantly.

A large cap value stock above 15 counts as overvalued but if the stock can still grow a couple percent per year then 20-22 P/E is still considered good.

A high growth stock P/E ratio can “go to the moon” even into the couple hundreds territory but usually it’s in the 25-45 territory. Tesla has had a P/E ratio of about 600 not that long ago (as of Aug 5, 2021 it’s 371) which is insane, even for a high growth stock. Alibaba Health (241.HK) P/E is 342 which is huge but still different than Tesla because Ali Health is backed by one of the largest companies of the World, Alibaba, so it seems to be in a much better position. But they’re in different industry so can’t really be compared.

For the banks P/E under 12 considered to be good .Mining companies or industrials might be even lower.

In normal conditions low P/E usually means that a company is undervalued while high P/E is overvalued. You don’t want to pay a price of a brand new Ferrari for a 20 year old Kia (high P/E) but you’re happy to buy a Ferrari for the price of a 20 year old Kia (low P/E).

So, when you value a stock always pay attention to the P/E ratio as it’s an important factor of the whole image but there are other important players in the game, too, which I’m going to share on this blog from time to time.

 

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