What actually is PER?
It's often said that the PER is an estimate of the number of years it'll take investors to recoup their money. Unless all profits are paid out as dividends, something that rarely persists in real life, this is incorrect.
So ignore what you might read in simplistic articles and note this down: a PER is a reflection not of what you earn from a stock, but “what investors as a group are prepared to pay for the earnings of a company”.
All things being equal, the lower the PER, the better.
But the list of caveats is long and vital to understand if you're to make full use of this metric.
Last financial year, XYZ Ltd made $8 million in net profit (or earnings).
Quality has a price to match
Quality usually comes with a price to match.
It costs more, for example, to buy handcrafted leather goods from France than it does a cheap substitute from China. Stocks are no different: high quality businesses generally, and rightfully, trade on higher PERs than poorer quality businesses.
Low PER doesn't alone guarantee quality business
Avoid a Common trap: Use underlying or normalised earnings in PER
There's another trap: PERs are often calculated using reported profit, especially in newspapers or on financial websites.
But one-off events often distort headline profit numbers and therefore the PER.
Using underlying, or “normalised”, earnings in your PER calculation is likely to give a truer picture of a stock's value.
What is a normalised level of earnings?
That begs the question; what is a normal level of earnings? That's the $64 million dollar question.
If you don't know how to calculate these figures for the stocks in your portfolio, now is the time to establish whether it's skill or luck that's driving your returns. And if you don't know that, history may well make a monkey of you.
An old encounter with low PE stock: Hai-O
It is nostalgic to re-read an old post on Hai-O by ze Moola.
http://whereiszemoola.blogspot.com/2008/04/more-on-haio.html
Sunday, April 13, 2008
MORE ON HAIO
My dearest BullBear,
A low PE stock means only one thing and that is the stock is trading on a lower valuation compared to what it is currently earning.
Some simply consider that what is happening is the stock is being ignored in the market despite its impressive earnings.
Why?
The market could be wrong and that perhaps this is a stock that's an ignored gem. Yeah, the classical hidden gem and if this is the case, investors who invests in the stock could be rewarded for their stock selection.
However, on the other hand, sometimes the market could be right and that they do sense something is not right within the stock.
And because of this reasoning, I have always realised that a low PE stock does not make a stock a QUALITY stock.
It just means the stock is trading 'cheaply'.
It could be a bargain but it could also be a trap.
It's often said that the PER is an estimate of the number of years it'll take investors to recoup their money. Unless all profits are paid out as dividends, something that rarely persists in real life, this is incorrect.
So ignore what you might read in simplistic articles and note this down: a PER is a reflection not of what you earn from a stock, but “what investors as a group are prepared to pay for the earnings of a company”.
All things being equal, the lower the PER, the better.
But the list of caveats is long and vital to understand if you're to make full use of this metric.
PER: Historical versus Forward or Forecast PER
The PER compares the current price of a stock with the prior year's (historical) or the current year's (forecast) earnings per share (EPS). Usually the prior year's EPS is used, but be sure to check first.
For example:
Last financial year, XYZ Ltd made $8 million in net profit (or earnings).
The company has 1 million shares outstanding.
So it achieved earnings per share (EPS) of $8.00 ($8 million profit divided by 1 million shares).
In the current year, XYZ is expected to earn $10 million; a forecast EPS of $10.00.
- At the current share price of $100, the stock is therefore trading on a historic PER of 12.5 ($100/$8).
- Using the forecast for current year's earnings, the forward or “forecast PER” is 10 ($100/$10).
Quality has a price to match
Quality usually comes with a price to match.
It costs more, for example, to buy handcrafted leather goods from France than it does a cheap substitute from China. Stocks are no different: high quality businesses generally, and rightfully, trade on higher PERs than poorer quality businesses.
Low PER doesn't alone guarantee quality business
- Value investors love a bargain. Indeed, they're defined by this quality.
- But whilst a low PER for a quality business can indicate value, it doesn't alone guarantee it.
- Because PERs are only a shortcut for valuation, further research is mandatory.
- Likewise, a high PER doesn't ensure that a stock is expensive.
- A company with strong future earnings growth may justify a high PER, and may even be a bargain.
- A stock with temporarily depressed profits, especially if caused by a one-off event, may justifiably trade at a high PER.
- But for a poor quality business with little prospects for growth, a high PER is likely to be undeserved.
Avoid a Common trap: Use underlying or normalised earnings in PER
There's another trap: PERs are often calculated using reported profit, especially in newspapers or on financial websites.
But one-off events often distort headline profit numbers and therefore the PER.
Using underlying, or “normalised”, earnings in your PER calculation is likely to give a truer picture of a stock's value.
What is a normalised level of earnings?
That begs the question; what is a normal level of earnings? That's the $64 million dollar question.
If you don't know how to calculate these figures for the stocks in your portfolio, now is the time to establish whether it's skill or luck that's driving your returns. And if you don't know that, history may well make a monkey of you.
An old encounter with low PE stock: Hai-O
It is nostalgic to re-read an old post on Hai-O by ze Moola.
http://whereiszemoola.blogspot.com/2008/04/more-on-haio.html
Sunday, April 13, 2008
MORE ON HAIO
My dearest BullBear,
A low PE stock means only one thing and that is the stock is trading on a lower valuation compared to what it is currently earning.
Some simply consider that what is happening is the stock is being ignored in the market despite its impressive earnings.
Why?
The market could be wrong and that perhaps this is a stock that's an ignored gem. Yeah, the classical hidden gem and if this is the case, investors who invests in the stock could be rewarded for their stock selection.
However, on the other hand, sometimes the market could be right and that they do sense something is not right within the stock.
And because of this reasoning, I have always realised that a low PE stock does not make a stock a QUALITY stock.
It just means the stock is trading 'cheaply'.
It could be a bargain but it could also be a trap.
No comments:
Post a Comment