P/E ratio: concept, interpretation, calculation formula, analysis and income

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P/E ratio: concept, interpretation, calculation formula, analysis and income
P/E ratio: concept, interpretation, calculation formula, analysis and income

When analyzing a company whose shares are traded on the market, it is extremely important to be able to quickly assess the ratio of the current market price of a security in comparison with, relatively speaking, the success of this company. In other words, whether a stock is overvalued, fairly valued, or undervalued. There is a whole set of financial ratios within the framework of fundamental analysis that allow such an assessment.

Share liquidity ratios

This data, including the P/E ratio, shows and converts key information about a company into a per share basis. These ratios allow you to understand what share of total revenue, profit, equity and dividends is accounted for per one single share of this company. This article is devoted to one of these tools - the P/E ratio.

What does this mean?

The abbreviation P/E, which is also used in Russian-language sources, literally means “price to earnings”, that is, literally translated “price to earnings”. The more familiar designation of this term in Russian is often used.- "multiple profits". The sometimes used term P/E ratio shows the same value and is also used in the relevant literature.

beautiful formula
beautiful formula

How to calculate?

The formula for calculating the P/E ratio is as follows:

Market share price / Earnings per share.

It is important to note here that profit does not mean the entire volume of the company's income, but net profit after payment of all taxes and dividends on preferred shares, per share of this company.

That is, before calculating this ratio, an intermediate calculation of earnings per share is required. This ratio is standardly abbreviated EPS, which stands for "earnings per share", literally - "earnings per share". The formula for calculating it is very simple:

Earnings per share=(Net income after all taxes - preferred stock dividends) / Number of shares outstanding.

Usually, these indicators are calculated on the basis of data obtained for one calendar year, and for analysis, they are considered in dynamics over a certain period of time. The initial data for such calculations can be obtained from the materials of the company's standard reporting, published in the public domain.

For example, with a company's total net profit for the year of 5 billion rubles and no dividend payments on preferred shares, 860,000 outstanding shares on the market and the current market share price of 120,000 rubles, you can calculate the coefficientP/E.

First we get EPS: rubles.

Then P/E ratio=120.000/ 5.813, 95=20, 6.

What does it mean?

The P/E ratio shows how the stock market is valuing a company's stock at the moment. At its core, this ratio expresses a simple fact - how many times the current market price of a share is greater than the net income generated by this one share. Or, more simply, how many annual profits are contained in the share price. One can also give the following interpretation: how many years will the investment in this share pay off if the business of this company proceeds in the same way as in the reporting year.

Everything goes up
Everything goes up

How can I apply?

By calculating this ratio, an investor is able to assess the fairness of a share's price relative to the earnings generated by the company per share. If the coefficient is of great importance, it is possible with a certain degree of certainty to conclude that the shares of this company are undervalued, and, having additionally studied its statements, make a decision to purchase shares based on an increase in their value. Too low readings can mean an inadequate valuation, a so-called "bubble" in these stocks, and signal the need to sell these shares before the negative moments in the market.

The above reasoning is typical for the so-called efficient stock market. However, often inexperienced investors act exactly the opposite, that is, focusing on high profitability, they primarily purchase shares of companies withlow P/E ratios.

It should be noted that enterprises and companies in various industries have significantly different levels of P/E. In slowly developing industries, such as pharmaceuticals or shipbuilding, these figures are significantly, often many times, higher than in dynamic industries such as the Internet industry, communications, and a number of others. The capital intensity of the industry is also of great importance. Therefore, it is often meaningless to compare this indicator for different companies. In order to improve the correctness of the analysis, the P / E ratio is calculated not only for the shares of individual companies, but also for entire sectors of the national economy, which provides an additional opportunity to identify a kind of “forerunners” in each industry with an appropriate basis for analysis. Similarly, the indicator "multiple profit" is calculated for stock indices, which are the average state of the stock market of a particular country.

Volatility is a good word
Volatility is a good word

Mathematical interpretation

The calculation formula is a quotient of division, where the numerator is the price of the share, and the denominator is the profitability of the share. Thus, if the numerator is stable, that is, the share price does not increase, but the denominator, which reflects profitability, constantly increases, the ratio falls. With this development of events, it is obvious that this stock is undervalued by the market. The reverse is also true. Therefore, when conducting an analysis, it is extremely important to study the behavior of the P / E ratio in dynamics, which allows you to estimate and extrapolate the future price of a particular stock.

Very gloomy
Very gloomy

Everyday interpretation

In fact, this coefficient, for ease of understanding, can be conditionally described as the ratio of the current market price of a rented apartment to the annual rent for it. If the apartment costs 15 million rubles, and the annual rent is 720 thousand rubles, then the coefficient will be equal to 20.8 (15.000/720). Which means that the cost of the apartment will be fully paid off by the cash flow from renting it out in 20.8 years.

The screen got hot
The screen got hot

Disadvantages of odds

In addition to the industry differences already mentioned, the P/E ratio of stocks has a number of disadvantages. First of all, it must be borne in mind that one of the main indicators used to calculate it, namely, profit, can be subjected to some, however, completely legal manipulation. This can be done due to the fact that profit is the difference between revenue, the amount of which is quite difficult to distort, and costs, the methods of writing off and reflecting which in accounting are quite diverse. Understatement of profits in order to optimize taxes is a fairly common phenomenon in all industries and countries. A negative P/E ratio occurs when there is a net loss in the reporting period instead of net profit. However, for new promising companies, this is a fairly common occurrence. In this case, the analysis for this instrument is simply impossible, as it can mislead the investor. The indicator is also ineffective in cases of imminent liquidation of the company, accompanied by a sale.assets and closing all debts of the company. However, the main drawback of the P / E ratio is that it reflects the past, and all investors are primarily interested in the future. However, this drawback is inherent in all indicators without exception.

Modified ratio

There are several types of multiples of earnings, so some care must be taken when analyzing them for different firms. The differences are mainly in the use of different indicators of profitability. Most often, the profit received by the company for the last reporting financial year is used for calculation. However, forecasted profit can often be used instead, in which case the ratio is called the “perspective P / E ratio”, or forecast ratio. A so-called "sliding" coefficient can also be applied, where quarterly data of the company are taken into account. The most “advanced” among the modified P/E ratios of stocks is CAPE (cyclically adjusted P/E ratio), or in Russian: “cyclically adjusted multiple of profit ratio”. This ratio is calculated on the basis of a moving 10-year average, discounted at the inflation rate for that period. Its use allows you to "smooth out" random jumps in the profits of the company or the price of its shares in the market. The calculation is quite laborious, but there are corresponding calculators in the public domain.

mobile applications
mobile applications

Global stock market

Since almost every country has its own stock market, it's rather pointlesstry to cover the immensity, that is, to give the P / E ratio of shares for individual companies, of which there are tens of millions. It is much more interesting to evaluate the dynamics of P/E for stock exchange indices, which allow making certain forecasts regarding the possible directions of further market movement.

Below is a chart of P/E ratios for the S&P500 index, which is an integral assessment of the 500 largest companies in retrospect.

Important Schedule
Important Schedule

Extremely high values of the "profit multiple" indicator almost always lead to the next financial crisis. Currently, the "average temperature in the hospital" is in the region of 20-21, which is quite high, but not critical. The chart also shows how much stock prices can sink after bursting “bubbles” in the market. If now and at the very beginning of the path, that is, at the end of the 19th century, the indicator was around 20, then during the years of the Great Depression it reached 4, that is, the share price on average was equal to only four annual company profits. At the peak of stock bubbles, stock prices soared to an average of 45 per share per year. It is noticeable that over time, the market later began to react to inadequate growth in share prices. At the beginning of the century before last, the decline began at a P/E ratio of 26, later at 34, and most recently only at 45.

Russian companies

P/E ratios of Russian stocks can be found in the following table:

Company name Capital billionRUB

Coefficient value


Rosneft 4871 21, 9
LUKOIL 4236 10, 6
Gazprom 3639 5, 1
NOVATEK 3280 20, 9
Gazpromneft 1835 7, 3
Nornickel 1815 14, 2
Severstal 872 8, 6
Yandex 659 42, 9
AFK Sistema 78 19, 0
Aeroflot 113 4, 9
KAMAZ 41 12, 2
M-Video 73 10, 5

As can be seen from the above data, we can conclude that a number of Russian companies are significantly undervalued. P/E ratios differ greatly depending on the industry in which a particular company operates, and are somewhat underestimated in relation to the current global level of P/E value in the region of 20.

Main Russian companies

Today, two companies can boast of the largest capitalization in Russia. These are the joint-stock company Gazprom and the number one bank in our country - Sberbank. On the Moscow Exchanges, the turnover on the shares of these two companies is more than half of the total turnover of trading floors. P / E ratio of Sberbank with a total capitalization, according to the latest annual reporting data of 4.2 trillion rubles,equals 5.8. Relatively speaking, investments in the shares of this bank pay off in 5.8 years. At the end of 2018, after a serious drop in prices, this asset has a coefficient of around 8, which is still quite low. Other banks that differ from Sberbank in terms of capitalization at times have higher values. For example, Vneshtorgbank is 8.2 and Rosbank is 9.2. companies in this industry. Rosneft and NOVATEK have ratios over 20, while LUKOIL over 10.

Instead of a conclusion

The Russian stock market is rather small compared to the global markets. And this is explained, first of all, by the passivity of the population, which has no idea about the possibilities of this direction. If in the United States more than half of citizens have investments in stocks and other securities, including for preparing for their retirement, then in Russia the number of people trading on the stock exchange does not exceed a few percent. In the context of problems with pension provision, lowering deposit rates, the stock market can become a serious help for Russian citizens in saving and increasing their money.