In spite of the development of newer valuation measures, Price Earnings Ratio is still the most widely used measure of the value of a company. Many Investor Relations Officers think of PE as measure of the success of their work. Is their company's PE rising? How does their PE compare with that of peer companies? The IRO seldom can effect Earnings, but may be able to influence PE. Although we are all well acquainted with the concept, the Investor Relations Officer should be aware of some important details.
First, in computing PE, what value does the investor pick for Earnings? For a company that is not growing, the most recent reported annual earnings will do. However, for a firm with growing earnings, more thought needs to be given before establishing a meaningful PE. A calculation can be made using the Earnings as reported at the end of the company's fiscal year, and the price on that day. Of course, this version of PE cannot be known until earnings are announced. A backward PE based upon current price and trailing year's earnings can be computed, but we have to estimate earnings since the most recent announcement. Investors usually look forward; pricing is based upon expectations, not history. A one year forward PE is based upon the next 12 months expected earnings and today's price. Forward earnings are, of course, based upon an estimate. The IRO may use his own estimate, or one based upon consensus analyst's, as reported by several services. For companies that are growing rapidly, the time frame for earnings can make a considerable difference in PE.
To make comparisons between companies, we must use the same time frame for earnings. Since all companies do not report on the same fiscal year, a correction must be made to get the earnings accrued over the previous 12 months (for the trailing calculation) or expected over the next 12 months (for the forward calculation)
Price Earnings CalculatorThe calculator below will let you try several approaches to computing PE. Enter the number of months until the companies fiscal year ends. If it is now the first of November 1999, and the fiscal year ends at the end of March 2000, enter 5. The trailing earnings calculation will use 7 months of the current year, the upcoming fiscal year end, plus 5 months from the previous year. The forward calculation will use 5 months of the current year plus 7 months from the subsequent year, ending March 2001. Enter last year's earnings and this year's projected earnings. For the forward calculation, enter an estimate for the subsequent year, or let the calculator project those earnings from rate of earnings growth. You can choose to assume earnings constant within each year, or growing by a constant amount.
PRICE EARNINGS CALCULATOR
Calculate Leading and Trailing Earnings
Previous Fiscal Year's Reported Earnings
Current Fiscal Year's Expected Earnings
Earnings Growth Rate
Months Since FY Ended
Fraction of Current Fiscal Year in upcoming 12 months
Trailing 12 Months Earnings
Upcoming 12 Months Earnings
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You can make adjustments in these Earnings Estimates before compute Price Earnings Ratios
Leading and Trailing Price Earnings Ratio
Current Price
P/E using Previous Year's Reported Earnings
P/E using Current Year's Expected Earnings
P/E using Trailing 12 Months Earnings
P/E using Upcoming 12 Months Earnings
Earnings Increase Changes in Next Fiscal Year
Expected Growth Rate (Percent)
Current Fiscal Year's Earnings
Expected Next Fiscal Year's Earnings
Contribution to Upcoming 12 months' Earnings from Next FY
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The description below is to remind you of your analysis when you Restore.
CALCULATING REASONABLE PRICE EARNINGS RATIOS
We expect companies with a higher growth rate to exhibit a higher PE, all else equal. In fact, a popular valuation rule is that the PE should equal the annual percent growth rate. This rule is usually applied to companies with high growth rate. Obviously the rule fails for firms that are not growing, we do not expect a zero PE!
As we will see, two other elements besides growth rate enter into PE. First, is what portion of the earnings need to be retains to finance future growth versus being returned to the owners. Second, is the length of time extraordinarily high growth can be maintained.
You may hear analysts refer to your company's EP, or Earnings Price Ratio, rather than PE. EP has some advantages over PE to quantitative managers. First, earnings very close to zero result in very large PE, but nearly zero PE. A small difference in earnings when near zero has a large effect of PE, but not a great effect on EP. EP is similar to other value measures, like dividend yield, which is Dividend divided by price, and Book to Price, Book value divided by Price. A large value indicates a value company, while a small value is associated with a growth company.
A company whose earnings have deteriorated, giving it a low EP may not seem like a growth investment, but why else would an investor purchase the stock if not anticipating growth? Some cyclic firms show earnings that fluctuate with the economic cycle, with perhaps a slow growth from cycle to cycle. PE can be best computed for these firms by averaging over a business cycle. For a cyclic industry, you expect stock price to rise as earnings reach the top of the cycle, but not rise as fast as earnings. Thus PE is low at the top of the cycle. At the bottom, earnings are depressed (perhaps even negative) , and price has fallen. However, price will anticipate a future upturn, resulting in a relatively high PE. To distinguish between cyclic stocks, it is important to compute PE over an entire business cycle. PE can be projected using a constant growth rate and payout ratio.
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