Using P/E for Stock Investment

Many investors uses Price/Earnings(P/E) when they are deciding whether to invest in a company, as it is easy to use and data for it is widely available. One can just take the current stock price divided by the latest earnings of the company and they can derive at the company's P/E. Some investor might try to do some forecasting by adding a growth factor in to the earning to derive at a forward P/E, as earning reports are normally reported quarterly  and based on past performance. By adding a growth factor you are essentially forecasting the company's future and be forward looking.

Once you derive at the P/E, how do you know it is a "bad" or "good" number? P/E can be compared in 3 different ways:

• With the market

You can compare the company's P/E with the market's P/E. If it is higher than market's, then it can be consider more "expensive" than the average stock, and if it is lower, then the opposite is true. However, this does not take into account the nature of different industries in the exchange, and some industries have very different P/E due to the business environment they operate in.

• With similar companies in the market

To counter the above mentioned problem, one can compare a company's P/E with companies in the same industry. For example, one can compare raffles medical with IHH, as both are in healthcare. This will give you a clearer picture as the companies compared are more/less operating in the same environment. However, the P/E differences could be due to the growth potential of the company, how leverage the firm is and even due to the management of the company.

• With historical P/E

Another way to use P/E is to look at the company's historical P/E and see if the company is currently over or under valued. However, one must take note that the change in current P/E might be due to the change in business mix or environment that the firm operate in, hence it is not useful or accurate to compare to the historical P/E of the company.

Another point to take note is that the earnings of the company might consist of one-time gain from sales of building or investment, and hence that might distort the actual earnings that are generate by the company's normal business. So you should discount that when you are calculating the P/E. One limitation of P/E is that it can not be used on loss-making firm, and hence a investor might have to use price/sales or other metric when making investment decision. In conclusion, P/E is a simple and easy way for a investor to use when making a investment decision, but one should look at other factors and not just rely solely on P/E.