Price-Earnings Ratio (PER)

As an investment measure, the Price-Earnings Ratio (PER) is, in many ways, like a ranging shot. It gives an investor an instant fix on the kind of company that is under review and the market's expectations.

The PER is best used to measure how much an investor is being asked to pay for future earnings. A growth stock with a higher prospective PER than the market average clearly anticipates above average future earnings growth. Conversely, a growth stock with a low PER expects below average future performance.

Very high PERs can be dangerous. The slightest setback to expectations can cause a vicious downturn in the share price. In contrast, low PER stocks are relatively safe, although often uninspiring. Utilities, for example, often trade on very low PERs.

Recovery stocks often command very high PERs at the bottom of their cycle when a substantial recovery is anticipated. At the top of the cycle, their PERs can then fall to below-average levels. Because of this, great care should be taken when comparing the PERs of companies in different sectors.

The weakness of the PER in isolation is that it does not tell you how much you are paying in relation to the estimated future growth in earnings. It is therefore a one-dimensional measure. For example, how much should be paid for a stock growing at 40% per annum compared with another growing at 20% per annum? The price earnings growth factor PEG - see below,
pinpoints the relationship between the PER and the growth rate, making it a far more pertinent and effective investment measure.

REFS has focused upon the 12 months immediately ahead as the most dynamic and useful measure of a company's PER. As already explained, the prospective normalised EPS figure is calculated by apportioning estimates from the current and following financial periods. For example, if the calculation was made on 1st April 1998 for a company with a year ending on 30th June 1998, a quarter of the estimate for the current year would be added to three-quarters of the estimate for the year ending 30th June 1999. As the prospective PER in REFS is based on the prospective normalised EPS figure, it will always cover the 12 months following the calculation date.

The method of calculation used in REFS ensures that the company entries are as up-to-date and dynamic as possible.

When future estimates are available, this is indicated by the letters 'pr' in brackets and the PER is based on the consensus forecast for the 12 months immediately ahead. If there is no forecast, historic figures based on the last reported 12 months results are used.

The PER is calculated by dividing the company's share price by its earnings per share (EPS). For example, if the share price of a company is 100p and its earnings per share are 5p, the PER is 20.

In May 1998, the average UK company had an historic PER of approximately 19 and, after forecast growth, a prospective PER of about 15. The forecast growth may seem to be substantial, but in fact a large element of it was anticipated recovery from previous setbacks as opposed to pure growth. Individual companies making up the market average of 15 had PERs ranging from 3 to over 150, but the vast majority were between 10 and 30.

The moons show the PER of a company relative to the market and then relative to its sector.