Friday, July 11, 2008

Three important ratios in share market

There are three important ratios for assessing a company's share, whether we can buy or not. They are:

1. Earnings per share (EPS)
2. Price to Earning ratio (P/E)
3. Price to future growth ratio (PEG)



1. Earnings per share (EPS)

EPS = (Net income of the company - dividend declared) / No of shares
where
Dividend declared = Amount declared as dividend by the company
No of shares = Average outstanding shares.. i.e if the company has 10 billion shares in first half of the year and if it has 15 billion shares in the second half of the year, we need to take average number of shares as 12.5 billion.

Three types of EPS -
Trailing EPS - Company's last year's number.
Current EPS - Company's this year's number. But are still projections.
Forward EPS - Future projections of the company's number.


2. Price to Earning ratio (P/E)

P/E = Stock Price / EPS

If P/E is high, that stock is called an over priced stock.
If P/E is low, then that stock loses the confidence among the investors.

P/E tells us, what the market thinks of a stock.

3. Price to future growth ratio (PEG)

PEG = (P/E) / (projected growth in earnings)

A stock with low projected growth in earnings has a high PEG ratio. So its not a good stock. But a stock with higher projected growth will have lower PEG. So we are in favour of low PEG numbers. This ratio helps us in deciding our stand for a public issue.

All these ratios are theoritical one. These can serve its purpose to some extent. But share market is subject to people's mind set. Its all completely in the hands of the investors to bring the share prices up or to pull it down. For example if all investors start selling a share as it has reached a price level where they can get a good amount of profit, eventually the price will come down. On the other hand, if the investors start buying a company's shares as it got quoted very low, but future projections has been very good, then the price of the shares will increase.

These ratios can be used to take the initial decision.

1 comment:

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