P/E Confusion

sting · 15 May 2007

I seem to be missing something here or have I got the concept of P/E ratio's wrong. I believe the lower the P/E the better the value... ie low share price/ high earnings

If this is so can someone please explain this...

I am currently researching a stock that's share price is just under $2.00 and returns via dividends an av 16 cents per share and yet its P/E ratio is 200.

How can this be...please explain

Semper Ubi Sub Ubi

Happy · 15 May 2007

Definition:

The price/earnings ratio (P/E) is a way to show how a company’s earnings relate to the stock price.

The P/E is calculated by dividing the current price of the stock by the annual earnings per share.

The higher the P/E the more earnings growth investors are expecting and the higher premium they are willing to pay for that anticipated growth

Is it possible that dividends don't go to this calculation?

As sometimes dividends are not paid from earned purse, but are paid from borrowed funds.

Happy · 15 May 2007

Found it –

To calculate the P/E we take the share price and divide it by the company’s Earnings per Share.

bvbfan · 19 May 2007

Okay so the P/E is 200 when price is about $2

Working backwards earnings is $2 / 200
therefore earnings is 0.01 (1c) where the hell is the dividend coming from if they are only earning 1c

Looks like the company is either paying dividends from retained earnings and if the business stays as is the likelyhood of the continuing these dividends seem unlikely long term.

Or

The dividend is the result of sale of some parts of the business.

If the company is a mining company it could be the mine is finished production and they are just paying out shareholders cash the company has until it has no cash backing.

nizar · 19 May 2007

Its also good to look at the EPS growth rate.
eg. pe of 25 is easily justified if the company is increasing earnings by 40% a year the next few years.

sting · 21 May 2007

Below is an extract from a company report.. it is not a mining company , it is a utility company all I can fault it is that it has extremely high debt ratio but i cant work out where the dividends are coming from

1.04 Earnings (cents) .9 1.9
1.60 Dividends (cents) 17.3 18.0
-- Franking (%)
-- Capital Spending
0.60 Book value
1,009 Shares outstanding (m)
-- Avg annual PE ratio (%)
-- Relative P/E (%)
-- Total Return (%)
-- +/- Market (%)
-- +/- Sector (%)
-- Revenues ($ million)
-- Operating Margin (%)
-- Depreciation ($ million)
-- Amortisation ($ million)
11 Net Profit Before Abnormals ($ million)
11 Net Profit ($ million)
14.9 Income Tax Rate (%)
-- Net Profit Margin (%)
-- Employees (thousands)
1,655 Long Term Debt ($ million)
608 Shareholders Equity ($ million)
5.72 Return on Capital (%)
1.73 Return on Equity (%)
154 Payout Ratio (%)

semper ubi sub ubi

dhukka · 21 May 2007

sting said:
I seem to be missing something here or have I got the concept of P/E ratio's wrong. I believe the lower the P/E the better the value... ie low share price/ high earnings

It's a common misconception to think a low P/E represents good value. Some businesses trade on low P/E multiples precisely because they are poor businesses which are of little value. In contrast a company trading on a high P/E may still represent good value if it is able to consistently produce high returns on invested capital.

The second important point is not to confuse P/E's as a measure of value. Here is an article explaining why.

Broadside · 21 May 2007

dividends can be paid from retained earnings...maybe they had strong profits/earnings in previous years and had one bad year or some extraordinary items which pushed down earnings, so we get a high PE ratio. If the company sees this as a one off they may choose to continue paying high dividends from retained earnings with the expectation that earnings will return to "normal" levels next year.

I don't know what company you are referring to but that is a scenario which may explain the discrepancy. Obviously maintaining high dividends when earnings are falling or using debt is unsustainable and irresponsible.

dhukka · 21 May 2007

sting said:
Below is an extract from a company report.. it is not a mining company , it is a utility company all I can fault it is that it has extremely high debt ratio but i cant work out where the dividends are coming from

1.04 Earnings (cents) .9 1.9
1.60 Dividends (cents) 17.3 18.0
-- Franking (%)
-- Capital Spending
0.60 Book value
1,009 Shares outstanding (m)
-- Avg annual PE ratio (%)
-- Relative P/E (%)
-- Total Return (%)
-- +/- Market (%)
-- +/- Sector (%)
-- Revenues ($ million)
-- Operating Margin (%)
-- Depreciation ($ million)
-- Amortisation ($ million)
11 Net Profit Before Abnormals ($ million)
11 Net Profit ($ million)
14.9 Income Tax Rate (%)
-- Net Profit Margin (%)
-- Employees (thousands)
1,655 Long Term Debt ($ million)
608 Shareholders Equity ($ million)
5.72 Return on Capital (%)
1.73 Return on Equity (%)
154 Payout Ratio (%)

semper ubi sub ubi

Yes this business is highly leveraged but more importantly its Return on Capital and Return on Equity are extremely poor. The fact that it has paid out more than it earned is unsustainable in the long run. Difficult to tell without knowing more about the company but judging by the high debt levels it could be raising debt to cover dividend payments.

sting · 21 May 2007

The company in question is SKI.. an electricity supply company in SA and VIC..I am assuming that the debt is due to the infrastructure purchased from the state governments

semper ubi sub ubi

Broadside · 21 May 2007

with regard to the initial post the lower the PE the better the value, well all things being equal, yes, but a low PE may be because of fundamental problems with the business, expected declining earnings in the near future or perhaps a short mine life....I think forward PE ratios say the next 2-3 years are much more useful than current PE ratios, they say the sharemarket is forward looking but in the micro cap end of the market it can be amazingly myopic and looking beyond the immediate can be rewarding.

hongwong · 22 May 2007

is this company a holding company or a fund like
BBP, BBI or BBW ?

If so the P/E is bad but divends seem to be a ++ ?

I think this is because these sorta of companies dont have earning until the companies they have invested in - payout ...

Could be wrong.

P/E Confusion

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