To value a share, you must know certain numbers which are important. To name a few, they are:
EPS (earnings per share
DY (dividend yield )
PER or PE (price-earnings ratio)
PSR (price to sales ratio)
NTA or NAV (net tangible asset value)
Gearing (sometimes called debt-equity-ratio)
The PE ratio is the most often talked about. It means the market price per share divided by the net earnings per share. One way of looking at it, is that a PE of 4 means that it will take 4 years to recoup your capital at the current rate of earnings.
Is buying a share at low PE the way to riches? Certainly not. PE alone is not the way to value a share. Wealth is not so easily created; otherwise any form five boy can become rich. You need to know very much more.
Sometimes it is better to buy at high PE than at low PE. When a share is selling at low PE, it means that the prospective earnings are poor and therefore its intrinsic value will be lowered. On the contrary, when it is selling at high PE, it means the prospective earnings are good and therefore its intrinsic value will be enhanced.
It is better to buy a good company in its bad year rather than a bad company in its good year. Think about it, and you will know what I mean.
Prospective earnings are forecast earnings which may turn out to be inaccurate. Hence, if you buy at high PE and your forecast earnings are wrong, the share price will not go up. On the contrary if you buy at low PE and earnings per share subsequently drop, your low PE will become high PE, and the share price will drop also, So you see, it all boils down to earnings.
Fundamental analysts are paid highly, because they are supposed to possess the ability to forecast EPS correctly. In reality, sad to say, many failed miserably.
“If you wish to enjoy the glory of the sunrise, you have to slog through the darkness of the night”. Do your homework, read more, upgrade yourself, and someday you will be rich.
To all my Christian readers, I wish them Merry Christmas and a Happy New Year.
