March 31 (Lagos) - P/E ratio is Price to earnings ratio. Now that is not likely to make any sense to a new comer investor so let us break it down a bit. The Price in the P/E ratio is the current stock price of a stock. The denominator or the "e" is Earnings per share. Therefore in order to calculate a stock's P/E ratio you have to first calculate the earnings per share.
What is earnings per share - It tells you how much a profit a company earns per 1 of its share. A company can have billions of shares outstanding so this ratio is critical to know how much a company is really worth in terms of its real earnings. So if a company makes 1 billion Naira profit and has 1 billion shares that means its earnings per share is N 1.00 per share.
This is how total shares count affects the P/E ratio of a Company. The more the shares, the lower the earnings per share out be. Therefore the denominator in the P/E ratio would be lower meaning the P/E ratio would be higher.
A higher P/E ratio is negative for a stock.
P/E ratio is practical sense is a calculation of how many years it will take for a business to justify its current valuation based on its current profitability. So if a Company has a P/E ratio of 30, it means it would take that company 30 years to earn its current valuation in terms of profits.
It is probably the most important ratio in investing and every investor should understand how P/E works carefully. If you come across a P/E ratio under 5, you can start exploring that stock more to see other metrics. However once you come across a P/E ratio above 30, you have to start being very careful with your investment.
In developed markets like USA, tech companies like Palantir, Salesforce, crowdstrike have P/E ratios above 100, that's because those companies are growing exponentially. Even well established tech companies like Apple, Microsoft and Google have a relatively high P/E of between 20-30X because they can justify that valuation with their growth.
However if you come across a dying power sector company or a old hotel company or an old restaurant with a P/E ratio anywhere above 5 - you need to start being very careful with your money.
Once you understand the basic P/E ratio - you can start learning about forward R/E ratio and trailing P/E ratios.