Don’t be fooled by the p/e ratio

The p/e ratio is a popular tool with investors, but it can be misleading. A better approach may be to use a 'smart' p/e ratio. Phil Oakley explains how.

Investors often focus on two key things when they buy a share: how much profit or earnings the company is making, and what price the shares are. That's why the price/earnings (p/e) ratio is so popular. This simply takes the share price and divides by earnings per share (EPS the company's after-tax profits divided by the number of shares in issue). Usually, the lower the p/e, the better a p/e of eight means you pay £8 for £1 of earnings, while a p/e of 20 means you pay £20.

A popular variation is the price/earnings to growth (PEG) ratio. This divides the p/e ratio by the expected earnings growth rate. This helps when analysing fast-growing firms it might be worth paying £20 for £1 of earnings if earnings are growing very rapidly. A PEG ratio of below one (where the earnings growth rate is higher than the p/e) indicates the share is cheap, given its growth rate.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free
https://cdn.mos.cms.futurecdn.net/flexiimages/mw70aro6gl1676370748.jpg

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up
Swipe to scroll horizontally
Share price (p)$501142.9p
EPS (e)$44.1520.4p
Simple p/e ratio (p/e)11.37.0
Calculating the smart' p/e ratioRow 3 - Cell 1 Row 3 - Cell 2
Market value$455bn£723m
Debt cash-$121.2bn£2,737m
Enterprise value (EV)$333.8bn£3,460m
Operating profit$55.24bn£326m
Full tax rate35%24%
Tax charge-$19.3bn-£78.2m
After-tax operating income (A)$35.9bn£247.8m
Smart' p/e (EV/A)9.314.0

Phil spent 13 years as an investment analyst for both stockbroking and fund management companies.

 

After graduating with a MSc in International Banking, Economics & Finance from Liverpool Business School in 1996, Phil went to work for BWD Rensburg, a Liverpool based investment manager. In 2001, he joined ABN AMRO as a transport analyst. After a brief spell as a food retail analyst, he spent five years with ABN's very successful UK Smaller Companies team where he covered engineering, transport and support services stocks.

 

In 2007, Phil joined Halbis Capital Management as a European equities analyst. He began writing for MoneyWeek in 2010.