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In stock investing and in value investing in the Philippines, we know that the market goes up and down. When it is up, the prices of stocks rise and it’s pretty tricky to find ones that are inexpensive. When it is down, the prices of stocks goes down too and it’s pretty tricky again to find the cheapest of the bunch.
So how do you find the a stock that’s reasonably priced? One indicator can tell you that. It’s called P/E ratio.
In this article, I’m going to discuss about what it is, how it’s used, its limitations, and the ranking of blue chip stocks from lowest to highest P/E ratio.
What is price-to-earnings ratio?
Price-to-earnings ratio, P/E ratio or PER refers to the relationship of the market price of a company stock to its annual earnings. In formula, it is expressed as price per share divided by earnings per share.
The market price is whatever is the price that the stock is trading in the market, while earnings per share can be the previous year or the past four quarters.
You can find the price of any Philippine company shares on the Philippine Stock Exchange (PSE), stock brokers, and finance websites such as Wall Street Journal and Bloomberg.
Earnings per share is obtained by dividing the total earnings of the company with the total number of outstanding shares. Its formula is:
Likewise, you can find the earnings per share from the annual and quarterly reports that companies submit to the Securities and Exchange Commission and published through the PSE website. Specifically, it is published on the income statement of the company. You may also find annual reports available on the website of the company.
Why use P/E?
Just like price-to-book-value-per-share, when you start looking for cheap stocks, you might be tempted to look and judge them at their market price.
Say that there are two companies that you’re considering and the only information you have are their stock prices. On the table, you might think that Company Y is more expensive. It is five times than the price of Company X.
But companies are not created equally. Some companies are growing more than others, they are better managed, or they have better future prospects of continued growth.
The P/E ratio gives more information than the market price. It tries to tie up what people are willing to pay to buy the shares (price) with the business.
Its primary goal is for you to know how far or how close its market price to the earnings reported by the company. What it does is to give an understanding if the prevailing price makes sense in the context of the business and its ability to earn out from its operations.
To better understand this, let’s use an analogy.
Suppose that you’re about to buy two sari-sari stores. Store A is on sale for ₱1,000, and Store B is on sale for ₱5,000. With that information alone, you would go for Store A because it’s cheaper.
Now, let’s consider their earnings. Imagine that Store A reports earnings of ₱100 and Store B, ₱1,000. Comparing their P/E ratio, we have:
As you can see Store B has a lower P/E ratio compared to Store A. We can interpret this data by saying that in Store B, we only have to spend ₱5 to get a business that earns ₱1. And that Store A actually is twice as expensive because we have to spend ₱10 to get the same ₱1 earning.
This means that the lower P/E ratio, the closer the price is to the earnings and therefore it’s “cheaper”. The higher the P/E ratio, the farther the price is from the earnings and therefore it’s “more expensive”.
I promise I’ll continue to discuss about P/E ratio, but let’s talk a bit about price per share.
Price per share is the price that investors are willing to pay to acquire a stock. It is subject to demand. The more there is demand for a stock, the higher its price goes. The opposite happens when there is less demand and people want to sell their shares, and the price plunges accordingly.
It’s also a subjective appreciation of the business. Some investors buy stocks that they are familiar with such as companies with established brand recall or robust marketing and advertising efforts. Like, someone buys a fastfood company stock because they eat there frequently, or subscribe to a power, water and telecom companies because these are things that they use daily.
Position traders also jack up prices. They are people who buy a stock when they think that it’s going to go up in a short term. Maybe they saw according to their analysis that a stock is poised to break out from some level and will continue to climb up higher in the next coming days or weeks, and they could gain a quick buck by the spread between purchase price and selling price.
Sometimes, company news can make or break the price per share such as when a corporation is reported to sign a lucrative corporate deal, acquisition or merger. When the government announced an invitation for a third telco a few years back, some technology stocks rose. Or when the Build, Build, Build program of the government was announced, stocks that are in construction, cement production and banking increased.
What this all means is that the market price can be so divorced from the fundamentals of the business. That they can be so high that investors lose the sense to look at whether it is realistically supported.
This is where P/E ratio can be of help. It can provide the cold bucket of reality when the market price has become so extraordinarily high.
How to interpret P/E ratio
If a company has a high P/E ratio, is it overvalued? If it’s just the price in relation to earnings and nothing else, then yes. It makes sense to go for lower P/E if that’s only indicator that is being considered. However, it can also be relative. For instance, is it higher than the average in the industry that the company is under? There might be a reason why the stock is valued highly. It might be regarded as growth company for instance.
If a company has a low P/E ratio, is it undervalued? Again, if it’s just the price and earnings, then yes. A low P/E might suggest that the company is undervalued.
Take note that there might be a reason why the stock is valued so low. It may not be liquid, so buying and selling may not be as easy as you want it to be. It may also have very low prospects for the future, the investing public does not trust the management, or it has history of dubious financial decisions.
What is considered high or low P/E ratio? There is no consensus on what is considered high or low P/E ratio. Usually, comparisons are done between companies engaged in similar businesses.
The P/E ratio of blue chip stocks
See below table of of the top 30 Philippine companies as of October 2019 arranged from the highest to lowest P/E ratio.
|FIRST GEN CORPORATION||FGEN||23.8||3.97||5.99|
|ALLIANCE GLOBAL GROUP, INC.||AGI||10.58||1.56||6.78|
|LT GROUP, INC.||LTG||13.96||1.54||9.06|
|DMCI HOLDINGS, INC.||DMC||8.37||0.9||9.3|
|Semirara Mining and Power Corporation||SCC||21.85||2.33||9.38|
|METROPOLITAN BANK & TRUST COMPANY||MBT||66.95||5.96||11.23|
|METRO PACIFIC INVESTMENTS CORPORATION||MPI||4.78||0.42||11.38|
|GLOBE TELECOM, INC.||GLO||1,768.00||150.3||11.76|
|ABOITIZ POWER CORP.||AP||36.9||2.88||12.81|
|ABOITIZ EQUITY VENTURES, INC.||AEV||51||3.75||13.6|
|GT CAPITAL HOLDINGS, INC.||GTCAP||828||58.44||14.17|
|ROBINSONS LAND CORPORATION||RLC||24.15||1.68||14.38|
|BDO UNIBANK, INC.||BDO||137.9||8.99||15.34|
|SECURITY BANK CORPORATION||SECB||189.5||12.27||15.44|
|BANK OF THE PHILIPPINE ISLANDS||BPI||89.6||5.57||16.09|
|PUREGOLD PRICE CLUB, INC.||PGOLD||38.1||2.24||17.01|
|MANILA ELECTRIC COMPANY||MER||357.8||20.45||17.5|
|BLOOMBERRY RESORTS CORPORATION||BLOOM||10.5||0.59||17.8|
|JG SUMMIT HOLDINGS, INC.||JGS||69.1||3.73||18.53|
|AYALA LAND, INC.||ALI||45.25||2.12||21.34|
|SAN MIGUEL CORPORATION||SMC||164.1||6.8||24.13|
|INTERNATIONAL CONTAINER TERMINAL SERVICES, INC.||ICT||120.6||4.81||25.07|
|ROBINSONS RETAIL HOLDINGS, INC.||RRHI||76.5||2.87||26.66|
|SM INVESTMENTS CORPORATION||SM||974.5||34.89||27.93|
|SM PRIME HOLDINGS, INC.||SMPH||35.6||1.21||29.42|
|JOLLIBEE FOODS CORPORATION||JFC||218||6.37||34.22|
|UNIVERSAL ROBINA CORPORATION||URC||150.4||4.32||34.81|
Limits of P/E ratio
Planning to use P/E ratio in evaluating companies? That’s great, but here are the limits.
It does not consider risk.
So you found a company with an attractive P/E ratio. Is it a good buy? Well, that’s the pitfall of this indicator. It does not tell you the whole story. It just tells you that the company’s current market valuation is pretty close to its earnings.
And that’s not actually good because it does not take the risk brought about by corporate debts. A company with a lot of debt runs into the risk of default, i.e. that they might not have the ability to pay, or have its income eaten away by its debt obligations.
It excludes forecast.
The P/E ratio does not take into account too the growth potential of the company, which is one of the key aspects when you’re trying to determine how much worth a business is.
Imagine for example two companies with the same P/E ratio. If one is predicted to hit 10% growth next year and the other only 5%, how do you think investors would react when they’re deciding what price they’re going to pay? Of course the company with a higher forecast would fetch higher in the market.
But that is an information that the ratio does not capture.
Earnings can be, uhm, tweaked.
I don’t really want to dwell on this but suffice it to say that there are ways to change the P/E without a corresponding change in the business. For instance, earnings per share can be increased when the company buys the shares back. With less number of shares, earnings per share increases and the lower the P/E becomes. Yet nothing actually changes with the worth of the business.
Not to mention that there are creative ways in accounting to inflate earnings.
It is an incomplete indicator.
All in all, it isn’t just an indicator that you would want to solely rely on. For instance, it doesn’t say anything about shareholder’s equity, return on equity, or margins.
P/E ratio is a tool that gives information about the proportion of the earnings from the stock price. It’s a shorthand way to know whether the stock is trading above or below the ability of the business to produce earnings.
However, it’s never wise to use it alone. It has to be used in tandem with other indicators.