Tuesday, July 26, 2016

How to Calculate ‘Price to Earnings Ratio’?

Voyaging the exciting field of value investing requires scholarship of some central yet simple financial metrics of which ‘Price to Earnings Ratio’, also christened ‘PE Ratio’, is a key member. In the present essay, let us discover it.

As the title indicates, the proportion has two components, Price and Earnings. Price is the current market price of the stock and earnings is ‘Earnings Per Share’ or ‘EPS’, the meaning and the mode of computation of which are published in separate articles, elsewhere on this site.

Continuing with the example of NMDC Ltd. used in the other essay, summarized information assembled from the audited financial statements of NMDC Ltd., for the financial year 2014-15 show: Operating revenue 12356.41, total expenses 4740.29, non operating income 2265.40, exceptional items of charge 113.01, corporation tax 396.47 and miscellaneous debits 0.44. All numbers are expressed in Indian Rupees (Rs.) in crores  (10 millions) and the company has an equity capital of Rs.396.47 crores of nominal value of Rs.1 each, that is 396.47 crore shares.

On drawing up the profits and loss statement, the results will be as follows:

Rs. In crores (one crore = 10 millions)
Total Operating Revenues
Total Expenses
Operating Profits
Non Operating Revenues
Profit Before Exceptional Items
Exceptional Items
Corporate Income Tax
Miscellaneous Charges
Net Profit for the year
Number of Equity Shares (In crores (10 millions) of nominal value of Rs.1 each
Applying the formula EPS = Net Profit ÷ number of equity shares
Earnings Per Share – Rs. Per share

The current market price (CMP) of the scrip on the website of the popular financial newspaper ‘The Economic Times’ today, 26th July, 2016, is Indian ‘Rupees’ 100.25.

‘Price to Earnings’ is obtained by dividing the CMP by the EPS. 

Therefore, PE = 100.25 ÷ 16.20 = 6.19.

Recommended PE multiple for making a purchasing decision is a number below 10, and this scrip meets the criterion.