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	12,356.41
Total Expenses	4,740.29
Operating Profits	7,616.12
Non Operating Revenues	2,265.40
Profit Before Exceptional Items	9,881.52
Exceptional Items	113.01
Corporate Income Tax	3,346.21
Miscellaneous Charges	0.44
Net Profit for the year	6,421.86
Number of Equity Shares (In crores (10 millions) of nominal value of Rs.1 each	396.47
Applying the formula EPS = Net Profit ÷ number of equity shares
Earnings Per Share – Rs. Per share	16.20

The current market price (CMP) of the scrip on the website of the popular financial newspaper ‘The Economic Times’ today, 26^th 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.

How to Calculate 'Earnings Per Share' or 'EPS'?

Contrary to conventional financial statements, profit and loss account, balance sheet and statement of cash flows, which portray the financial picture in the company’s perspective, ‘Earnings Per Share (EPS)’ interprets the same information from the shareholder’s viewpoint. Mostly investors are interested in knowing what the corporation has earned for them, and EPS fulfills this requirement, exactly. In this article, let us examine how EPS is calculated.

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).

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

	Rs. In crores (10 millions)
Total Operating Revenues	12,356.41
Total Expenses	4,740.29
Operating Profits	7,616.12
Non Operating Revenues	2,265.40
Profit Before Exceptional Items	9,881.52
Exceptional Items	113.01
Corporate Income Tax	3,346.21
Miscellaneous Charges	0.44
Profit for the year	6,421.86

The balance sheet and schedule number 2.1 reveals that the company has an equity capital of Rs.396.47 crores of nominal value of Rs.1 each, that is 396.47 crore shares.

Dividing the net profit for the year by total number of equity shares we obtain he ‘Earnings Per Share (EPS)’.

	Rs. In crores (10 millions)
Profit for the year	6,421.86
Number of Equity Shares ( In crores (10 millions) of nominal valye of Rs.1	396.47
Earnings Per Share – Rs. Per share	16.20

Our mathematical labors reveal that NMDC Ltd., had earned for its members Rs.16.20 for every equity share having a face value of Rs.1. On the current market price of the share of Rs.98.10, the EPS amounts to a tax-free return of 16.51%, indeed impressive, considering obtainable interest rate of about 7.50% for bank fixed deposits, which attract a tax rate of about 33%.

Thus, ‘Earnings Per Share’ or ‘EPS’ throws valuable perspective of the returns earned by the investee corporation for its shareholder.