Equity Crowdfunding
The Shortcomings of an IPO The initial public offer model works well for big companies. However, as far as smaller start-ups are concerned, IPOs are not a viable or efficient means of raising capital. This is because there is a huge transaction, as well as legal fees that are associated with IPOs. Hence, as long […]
Uber’s New Businesses
Uber is already a well-known brand across the world. Technically, the company is still a startup. However, Uber has a valuation of close to $70 billion. Also, the company is planning for an aggressive IPO. It is estimated that Uber’s post IPO valuation will be close to $120 billion. This is phenomenal given the fact […]
Secondary Revenue Streams in Retail
The retail sector has been in doldrums in the recent past. The entire industry is struggling financially. The financial troubles within the retail sector are indigenous. However, time and again, external shocks such as Covid-19 and Brexit exacerbate the financial trouble. The end result is a large wave of bankruptcies. These bankruptcies do not only […]
Concept of Profit Booking and How It Affects Stock Markets
If you have regularly observed the stock market, you may have noticed that a lot of time when the market falls, experts attribute this fall to profit booking. The concept of profit booking is known to a lot of people. However, the knowledge is merely superficial. In this article, we will have a closer look […]
Types of Covenants
In the previous article, we had a closer look at the concept of covenants as well as indentures. However, we only covered the basics. Indentures and covenants are extremely important to the investors who deploy their money in fixed-income securities. It is for this reason that investors need to have a better understanding of the […]
The price to earnings ratio is the most fundamental of all market related ratios. It has been used for decades by stalwarts in the investment community. However, it is also the ratio that has come under maximum fire from the skeptics. A variety of measurements have been developed to compensate for what skeptics call the lack of correct information provided by the price earnings ratio. Almost all other market related ratios are a variation of the price to earnings ratio.
Price to Earnings Ratio = Current Market Price / Reported Earnings of the Company
The price to earnings ratio tells the investors how many rupees they are paying for every rupee in earnings that the company presently has. If the price to earnings ratio is 5, then investors are paying 5 rupees to get a stream of earnings of 1 rupee per year till perpetuity. This ratio therefore also implicitly tells the payback period which in this case would be 5 years.
There are a lot of assumptions that the price to earnings ratio implicitly makes. This is the reason that this ratio has come under a lot of criticisms from skeptics who think that price to earnings ratio provides a distorted image of what the reality of the company really is. The common assumptions are as follows:
The world is yet to see a company that has been able to generate stable earnings for an extended period of time. This is why the price earnings ratio may present reality to be different than what it really is.
Moreover the investment community may not enough data at hand to adjust these earnings and arrive at a figure which they think are fair earnings of the company. Hence, naive investors who only look at price-earnings ratios without looking at whether the earnings have been manipulated will possibly make wrong decisions based on this number.
The price to earnings ratio must be interpreted in the light of the fundamentals of finance. These fundamentals are the fact that an investment grows over a period of time. This growth pattern usually follows an exponential pattern which makes the phenomenon of compounding so important.
The fact that price to earnings ratio uses simple arithmetic division makes it unacceptable to many skeptics in the investment community.
Your email address will not be published. Required fields are marked *
