Sunday, January 15, 2017

New Explanation for PE and PB Ratios

So the morale of the Untold Story that I want to portray is that:

1) Please don't anyhow follow the trend, follow the people, follow the tips;

2) Do your own analysis and make your own decision.

I believe if you constantly make your own decision, you will slowly find the right criteria and start making gains!

To assist a newbie on making this decision, I suggest using these 2 ratios to see if the particular counter is TOO SIGNIFICANTLY OVERVALUED.

1) PE Ratio 

The first ratio is the regular Price to Earning Ratio. It is basically taking the Share Price divided by Net Profit per share (There maybe other calculations on the net, but I believe this is the most popular calculation of this financials). To understand this ratio further, it is good to get a counter with a low PE Ratio.

For this ratio, I interpret it as Price to Expectation Ratio. The higher the ratio, the higher the expectation of its up-coming earnings/net profit.

Therefore, if the net profit falls below investor's expectation, the share price will drop subsequently.

2) PB Ratio

The second ratio is the regular Price to Book Ratio. It is basically taking the Share Price divided by Equity per share (There maybe other calculations on the net, but I believe this is the most popular calculation of this financials). To understand this ratio further, it is good to get a counter with a low PB Ratio.

For this ratio, I interpret it as Price to Build-Up Ratio.

The higher the ratio, the longer the time is required to build up the company/balance sheet. For example, if the Price to Build-Up Ratio is 10, we can deem it as the company may require 10 years to build up its balance sheet that is similar to its share price. Therefore, the shorter the time is required, the better it is.

With the above new explanation of the old ratios, I hope it can help newbies to understand these ratios and, at least in future, use these simple ratios in their decision making of making future purchases.

Please do remember, like our Facebook page (T.U.B Investing) and follow me on InvestingNote.

2 comments:

  1. maybe can add on to your post:
    Don't take one year of earnings seriously. That applies to 1 year's of PE.

    Example: GSK has a single digit PE last year, but a triple digit PE the next

    PB is only useful but there are many pit falls to look out for. Value traps, deteriorating balance sheet, suspicious interested person transaction... etc. Buy a list of these to diversify the risk.

    ReplyDelete
    Replies
    1. Hi Boon Song,

      Totally agree. But it is hard to get everyone to use these numbers. So since almost all screeners has these 2 ratios, I assume taking 1 year of earnings is still better than taking none.

      Regards,
      TUB

      Delete