SHARE VALUE TIPS
How do you find a Company ripe for investment?
PRICE earnings ratios are helpful for investors trying to calculate whether a share is worth the investment but are not the only guide.
Studying P/E ratios should enable judgements to be made on which shares represent value and which ones are overpriced. However, making investment decisions based solely on P/E ratios could leave investors uniformed as to a company's growth potential.
A share's P/E ratio is calculated by dividing its share price by its earnings (profit) a share. It shows how long profits will take to pay off the market value of the company.
Investors should not confuse this with how many years it would take to have the investment paid back because shareholders receive dividends, not the actual earnings of a business.
Generally, a company with a low P/E can be considered a better value stock than one with a high P/E. But that ignores the strong performers considered to be growth stocks whose shares have a premium on them based on expectations that they will grow quickly.
Most analysts use future earnings to calculate prospective P/Es or the number of times the share price covers expected growth. This ensures calculations are forward-looking rather than based on historic P/E information.
P/Es are a good starting point for investors but dividend yield is another important indicator.
From a comparative data perspective, investors should also look at a public company relative to its peers and sectors to determine whether or not a particular stock is over or under valued.
A company with a P/E of 18 compared with a sector average of 20 is said to trade at a 10 per cent discount. If the same company had historically traded at a premium to its sector with a higher P/E then we may consider the company undervalued. However, if earnings growth has deteriorated or if some other characteristic has changed, the company may not be undervalued.
Analysts also use a number of other indicators to calculate a company's financial health.
Return on equity, which indicates the rate of profit the company made for shareholders as well as return on assets, provides insights into a company's profitability. Ratios such as the share price to net tangible assets as well as debt to equity and interest cover calculations also can help investors' estimations of a company's worth.
The share price divided by a company's net tangible assets measures the theoretical discount or premium to the share price with reference to tangible assets.
A very high ratio can indicate the share price is overvalued.
Debt to equity measures a company's reliance on debt finance compared with equity funding. Higher levels of debt can indicate a company has a greater exposure to interest rate rises. Low debt to equity ratios can be viewed more favourably.
Interest cover is a measure of how comfortably a company's profit covers its interest cost. A high ratio indicates a company is able to service its interest costs comfortably.
Analysts can also use a price earnings growth ratio that captures share price, earnings and earnings growth information.
For further information, please contact Geoff O'Neil - Director
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