P/E ratio can help us determine whether a company is over- or under-valued. But P/E analysis is only valid in certain circumstances and it has its pitfalls. Some factors that can undermine the usefulness of the P/E ratio include:
Accounting Earnings is an accounting figure that includes non-cash items. Furthermore, the guidelines for determining earnings are governed by accounting rules (Generally Accepted Accounting Principles (GAAP)) that change over time and are different in each country. To complicate matters, EPS can be twisted, prodded and squeezed into various numbers depending on how you do the books. The result is that we often don't know whether we are comparing the same figures, or apples to oranges. (For more on this, see Different Types Of EPS.) Inflation In times of high inflation, inventory and depreciation costs tend to be understated because the replacement costs of goods and equipment rise with the general level of prices. Thus, P/E ratios tend to be lower during times of high inflation because the market sees earnings as artificially distorted upwards. As with all ratios, it's more valuable to look at the P/E over time in order to determine the trend. Inflation makes this difficult, as past information is less useful today. Many Interpretations A low P/E ratio does not necessarily mean that a company is undervalued. Rather, it could mean that the market believes the company is headed for trouble in the near future. Stocks that go down usually do so for a reason. It may be that a company has warned that earnings will come in lower than expected. This wouldn't be reflected in a trailing P/E ratio until earnings are actually released, during which time the company might look undervalued. What goes up ... well, sometimes it stays up for an awfully long time.
A common mistake among beginning investors is the short selling of stocks because they have a high P/E ratio. If you aren't familiar with short selling, it's an investing technique by which an investor can make money when a shorted security falls in value. (For more on this, check out the Short Selling tutorial.) First of all, we believe that novice investors shouldn't be shorting. Secondly, you can get into a lot of trouble by valuing stocks using only simple indicators such as the P/E ratio. Although a high P/E ratio could mean that a stock is overvalued, there is no guarantee that it will come back down anytime soon. On the flip side, even if a stock is undervalued, it could take years for the market to value it in the proper way. Security analysis requires a great deal more than understanding a few ratios. While the P/E is one part of the puzzle, it's definitely not a crystal ball.
Friday, March 14, 2008
Price /Earning ratio of a Stock
When it comes to valuing stocks, the price/earnings ratio is one of the oldest and most frequently used metrics. Although a simple indicator to calculate, the P/E is actually quite difficult to interpret. It can be extremely informative in some situations, while at other times it is next to meaningless. As a result, investors often misuse this term and place more value in the P/E than is warranted.
As the name implies, to calculate the P/E, you simply take the current stock price of a company and divide by its earnings per share (EPS):
P/E Ratio = Market Value per Share
Earnings per Share(EPS)
Most of the time, the P/E is calculated using EPS from the last four quarters. This is also known as the trailing P/E. However, occasionally the EPS figure comes from estimated earnings expected over the next four quarters. This is known as the leading or projected P/E. A third variation that is also sometimes seen uses the EPS of the past two quarters and estimates of the next two quarters. There isn't a huge difference between these variations. But it is important to realize that in the first calculation, you are using actual historical data. The other two calculations are based on analyst estimates that are not always perfect or precise. Companies that aren't profitable, and consequently have a negative EPS, pose a challenge when it comes to calculating their P/E. Opinions vary on how to deal with this. Some say there is a negative P/E, others give a P/E of 0, while most just say the P/E doesn't exist. Historically, the average P/E ratio in the market has been around 15-25. This fluctuates significantly depending on economic conditions. The P/E can also vary widely between different companies and industries. Theoretically, a stock's P/E tells us how much investors are willing to pay per dollar of earnings. For this reason it's also called the "multiple" of a stock. In other words, a P/E ratio of 20 suggests that investors in the stock are willing to pay $20 for every $1 of earnings that the company generates. However, this is a far too simplistic way of viewing the P/E because it fails to take into account the company's growth prospects.
Growth of Earnings Although the EPS figure in the P/E is usually based on earnings from the last four quarters, the P/E is more than a measure of a company's past performance. It also takes into account market expectations for a company's growth. Remember, stock prices reflect what investors think a company will be worth. Future growth is already accounted for in the stock price. As a result, a better way of interpreting the P/E ratio is as a reflection of the market's optimism concerning a company's growth prospects. If a company has a P/E higher than the market or industry average, this means that the market is expecting big things over the next few months or years. A company with a high P/E ratio will eventually have to live up to the high rating by substantially increasing its earnings, or the stock price will need to drop. A good example is Microsoft. Several years ago, when it was growing by leaps and bounds, and its P/E ratio was over 100. Today, Microsoft is one of the largest companies in the world, so its revenues and earnings can't maintain the same growth as before. As a result, its P/E had dropped to 43 by June 2002. This reduction in the P/E ratio is a common occurrence as high-growth startups solidify their reputations and turn into blue chips. Cheap or Expensive? The P/E ratio is a much better indicator of the value of a stock than the market price alone. For example, all things being equal, a $10 stock with a P/E of 75 is much more "expensive" than a $100 stock with a P/E of 20. That being said, there are limits to this form of analysis - you can't just compare the P/Es of two different companies to determine which is a better value. It's difficult to determine whether a particular P/E is high or low without taking into account two main factors:
1. Company growth rates - How fast has the company been growing in the past, and are these rates expected to increase, or at least continue, in the future? Something isn't right if a company has only grown at 5% in the past and still has a stratospheric P/E. If projected growth rates don't justify the P/E, then a stock might be overpriced. In this situation, all you have to do is calculate the P/E using projected EPS.
2. Industry - It is only useful to compare companies if they are in the same industry. For example, utilities typically have low multiples because they are low growth, stable industries. In contrast, the technology industry is characterized by phenomenal growth rates and constant change. Comparing a tech company to a utility is useless. You should only compare high-growth companies to others in the same industry, or to the industry average. You can find P/E ratios by industry on Yahoo! Finance.
As the name implies, to calculate the P/E, you simply take the current stock price of a company and divide by its earnings per share (EPS):
P/E Ratio = Market Value per Share
Earnings per Share(EPS)
Most of the time, the P/E is calculated using EPS from the last four quarters. This is also known as the trailing P/E. However, occasionally the EPS figure comes from estimated earnings expected over the next four quarters. This is known as the leading or projected P/E. A third variation that is also sometimes seen uses the EPS of the past two quarters and estimates of the next two quarters. There isn't a huge difference between these variations. But it is important to realize that in the first calculation, you are using actual historical data. The other two calculations are based on analyst estimates that are not always perfect or precise. Companies that aren't profitable, and consequently have a negative EPS, pose a challenge when it comes to calculating their P/E. Opinions vary on how to deal with this. Some say there is a negative P/E, others give a P/E of 0, while most just say the P/E doesn't exist. Historically, the average P/E ratio in the market has been around 15-25. This fluctuates significantly depending on economic conditions. The P/E can also vary widely between different companies and industries. Theoretically, a stock's P/E tells us how much investors are willing to pay per dollar of earnings. For this reason it's also called the "multiple" of a stock. In other words, a P/E ratio of 20 suggests that investors in the stock are willing to pay $20 for every $1 of earnings that the company generates. However, this is a far too simplistic way of viewing the P/E because it fails to take into account the company's growth prospects.
Growth of Earnings Although the EPS figure in the P/E is usually based on earnings from the last four quarters, the P/E is more than a measure of a company's past performance. It also takes into account market expectations for a company's growth. Remember, stock prices reflect what investors think a company will be worth. Future growth is already accounted for in the stock price. As a result, a better way of interpreting the P/E ratio is as a reflection of the market's optimism concerning a company's growth prospects. If a company has a P/E higher than the market or industry average, this means that the market is expecting big things over the next few months or years. A company with a high P/E ratio will eventually have to live up to the high rating by substantially increasing its earnings, or the stock price will need to drop. A good example is Microsoft. Several years ago, when it was growing by leaps and bounds, and its P/E ratio was over 100. Today, Microsoft is one of the largest companies in the world, so its revenues and earnings can't maintain the same growth as before. As a result, its P/E had dropped to 43 by June 2002. This reduction in the P/E ratio is a common occurrence as high-growth startups solidify their reputations and turn into blue chips. Cheap or Expensive? The P/E ratio is a much better indicator of the value of a stock than the market price alone. For example, all things being equal, a $10 stock with a P/E of 75 is much more "expensive" than a $100 stock with a P/E of 20. That being said, there are limits to this form of analysis - you can't just compare the P/Es of two different companies to determine which is a better value. It's difficult to determine whether a particular P/E is high or low without taking into account two main factors:
1. Company growth rates - How fast has the company been growing in the past, and are these rates expected to increase, or at least continue, in the future? Something isn't right if a company has only grown at 5% in the past and still has a stratospheric P/E. If projected growth rates don't justify the P/E, then a stock might be overpriced. In this situation, all you have to do is calculate the P/E using projected EPS.
2. Industry - It is only useful to compare companies if they are in the same industry. For example, utilities typically have low multiples because they are low growth, stable industries. In contrast, the technology industry is characterized by phenomenal growth rates and constant change. Comparing a tech company to a utility is useless. You should only compare high-growth companies to others in the same industry, or to the industry average. You can find P/E ratios by industry on Yahoo! Finance.
Wednesday, February 27, 2008
How do you talk to a baby
The roads to communication with a baby are endless, and each parent travels some more than others. Here are some you may want to take:
Do a running commentary: Don’t make a move, at least when you are around your baby, without talking about it. Narrate the dressing process: “ Now I’m putting nappy….here goes the T-shirt over your head…. Now I’m buttoning your dungarees”. In kitchen describe washing of dishes, or process of making a dish. During the bath explain about the soap and rinsing, and that a shampoo makes the hair shiny and clean. It doesn’t matter that your baby hasn’t the slightest inkling of what you’re talking about. Blow-by-bowl descriptions help get you talking and baby listening – thereby starting him or her on the path to understanding.
Ask a lot: Don’t wait until your baby starts having answers to start asking questions. Think of yourself as a reporter, your baby as an intriguing interviewer. The questions can be as varied as your day: ‘Would you like to wear the red trouser or the green one?’ ‘Isn’t the sky a beautiful blue today?’ ‘Should I buy green beans or broccoli for dinner?’ Pause for an answer ( one day your baby will surprise you with one), and then supply the answer yourself, out loud (‘Broccoli? Good choice’).
Give baby a chance: Studies show that infants whose parents talk with them rather than at them learn to talk earlier. Give your baby a chance to get in a coo, a gurgle or a giggle. In your running commentaries, be sure to leave some openings for baby’s comments.
Keep it simple – some of the time: Though in the second month your baby would probably derive listening pleasure from a dramatic recitation of Hamlet’s soliloquy or an animated assessment of the economy, as he or she gets bit older, you’ll want to make it easier to pick out individual words. So at least part of the time, make a conscious effort to use simple sentences and phrases: ‘See the light’, ‘Bye-bye’, ‘Baby’s fingers, baby’s toes’, and ‘Nice doggie’.
Put aside pronouns: It’s difficult for a baby to grasp that ‘I’ or ‘me’ or ‘you’ can be mummy, or daddy, or grandma, or even baby – depending on who’s talking. So most of the time, refer to yourself as ‘mummy’ or ‘daddy’ or ‘grandma’ and to your baby by name: ‘Now mummy is going to change Sonu’s nappy’.
Raise your pitch: Most babies prefer a high pitched voice, which may be why women’s voices are usually naturally higher-pitched than men’s, and why most mothers’ voices climb an octave or two when addressing their infants. Try raising your pitch when talking directly to your baby, and watch the reaction.
Imitate: Babies love the flattery that comes with imitation. When baby coos, coo back; when he or she utters and ‘Ahh’ , utter one, too. Imitation will quickly become a game that you’ll both enjoy, and which will set the foundation for baby’s imitating your language – it will also help build self-esteem (‘What I say matters’).
Set it to music: Don’t worry if you can’t carry a tune – little babies are notoriously undiscriminating when it comes to music. They’ll love what you sing to them whether it’s a current hit, an old favorite or just some nonsense you’ve set to familiar tune.
Read aloud: Though at first the words will have no meaning to baby, it’s never too early to begin reading some simple rhyming stories or board books out loud. When you aren’t in the mood for baby talk and crave some adult-level stimulation, share your love of literature (or recipes or gossip or politics) with your little one by reading what you like to read, aloud.
Take your clues from baby: Incessant chatter and song can be tiresome for anyone, even an infant. When your baby becomes inattentive to your wordplay, close or averts his or her eyes, become fussy or cranky, or otherwise indicates the verbal saturation point has been reached, give it a rest.
Do a running commentary: Don’t make a move, at least when you are around your baby, without talking about it. Narrate the dressing process: “ Now I’m putting nappy….here goes the T-shirt over your head…. Now I’m buttoning your dungarees”. In kitchen describe washing of dishes, or process of making a dish. During the bath explain about the soap and rinsing, and that a shampoo makes the hair shiny and clean. It doesn’t matter that your baby hasn’t the slightest inkling of what you’re talking about. Blow-by-bowl descriptions help get you talking and baby listening – thereby starting him or her on the path to understanding.
Ask a lot: Don’t wait until your baby starts having answers to start asking questions. Think of yourself as a reporter, your baby as an intriguing interviewer. The questions can be as varied as your day: ‘Would you like to wear the red trouser or the green one?’ ‘Isn’t the sky a beautiful blue today?’ ‘Should I buy green beans or broccoli for dinner?’ Pause for an answer ( one day your baby will surprise you with one), and then supply the answer yourself, out loud (‘Broccoli? Good choice’).
Give baby a chance: Studies show that infants whose parents talk with them rather than at them learn to talk earlier. Give your baby a chance to get in a coo, a gurgle or a giggle. In your running commentaries, be sure to leave some openings for baby’s comments.
Keep it simple – some of the time: Though in the second month your baby would probably derive listening pleasure from a dramatic recitation of Hamlet’s soliloquy or an animated assessment of the economy, as he or she gets bit older, you’ll want to make it easier to pick out individual words. So at least part of the time, make a conscious effort to use simple sentences and phrases: ‘See the light’, ‘Bye-bye’, ‘Baby’s fingers, baby’s toes’, and ‘Nice doggie’.
Put aside pronouns: It’s difficult for a baby to grasp that ‘I’ or ‘me’ or ‘you’ can be mummy, or daddy, or grandma, or even baby – depending on who’s talking. So most of the time, refer to yourself as ‘mummy’ or ‘daddy’ or ‘grandma’ and to your baby by name: ‘Now mummy is going to change Sonu’s nappy’.
Raise your pitch: Most babies prefer a high pitched voice, which may be why women’s voices are usually naturally higher-pitched than men’s, and why most mothers’ voices climb an octave or two when addressing their infants. Try raising your pitch when talking directly to your baby, and watch the reaction.
Imitate: Babies love the flattery that comes with imitation. When baby coos, coo back; when he or she utters and ‘Ahh’ , utter one, too. Imitation will quickly become a game that you’ll both enjoy, and which will set the foundation for baby’s imitating your language – it will also help build self-esteem (‘What I say matters’).
Set it to music: Don’t worry if you can’t carry a tune – little babies are notoriously undiscriminating when it comes to music. They’ll love what you sing to them whether it’s a current hit, an old favorite or just some nonsense you’ve set to familiar tune.
Read aloud: Though at first the words will have no meaning to baby, it’s never too early to begin reading some simple rhyming stories or board books out loud. When you aren’t in the mood for baby talk and crave some adult-level stimulation, share your love of literature (or recipes or gossip or politics) with your little one by reading what you like to read, aloud.
Take your clues from baby: Incessant chatter and song can be tiresome for anyone, even an infant. When your baby becomes inattentive to your wordplay, close or averts his or her eyes, become fussy or cranky, or otherwise indicates the verbal saturation point has been reached, give it a rest.
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