The P/E Ratio

I have a degree in accounting and currently taking exams to be a registered financial planner. Although reading financial statements does not gives me head ache, I find that understanding all these ratios that come with the FS is quite a tough task.

So, today i'm going to write down my understanding on P/E Ratio. As an example, i'll take figures from Malayan Banking Bhd.

P/E = market price of share/Earnings per Share (EPS).

Quoting today's price for MBB @ RM6.89 per share;
EPS of 14.04 (source - the star online)
My acceptable P/E Ratio for investment in MBB is 9 times.

Before that, let's look at what is EPS. EPS is how much we earn for every shares we own. For MBB, we are getting RM14.04 for every shares that we own. If I have 100 MBB shares now, I would be getting RM1404.00!. Wow, not a bad choice huh?... So, should I buy or should I not?.

So, let's look at P/E ratio.We calculate P/E ratio to determine how much money are we willing to spend based on the EPS. We have the EPS and we have the acceptable P/E Ratio so the acceptable market price should be...

Acceptable Market Price = EPS x P/E Ratio
14.04 x 9
RM126.36.

Wow!. if I have the money, I should be buying as much as possible!.

This is one way of looking at the ratio. Another way is by looking at the current Market Price. For MBB the CMP is RM6.89. So, the P/E would be 0.49 which is very much below my acceptable P/E ratio of 9. So, I SHOULD BUY MBB.

BUT do bear in mind that the publish EPS is a historical figure and our decision might be wrong. To be on the safe side, we should based our calculation on projected/expected future earnings.

Happy Investing RMY!