How to invest in a trading company using PER?
Definition of a trading company’s PER
Investing in a trading company is never a bad choice. Many of the analysts at Tradeo.com believe this might be one of the most profitable investments. That is, under the condition that a person conducts proper analysis prior to the fact. There are many tools that can help you determine the potential of a trading company. They all have an interest behind, as always. The price earnings ratio (PER) should always be part of your arsenal of indicators to focus in your analysis.
The PER is relatively simple to understand. It allows you to get an idea about the value of a trading company. However, it should not neglect other issues such as indebtedness, its market potential and the industry in which it operates. The price earnings ratio (PER or P / E) is defined by the ratio of current profits.We can calculate it in two ways: by dividing market capitalization by net income or by dividing the stock price by earnings per share.
Consider a trading company whose stock value is 100 euros, for argument’s sake, and whose net income per share is 10 euros. The PER will be equal to 10 (100/10). Many people usually calculate it on an annual basis. But many analysts prefer quarterly data or forecast based on anticipation of expected on profits.
How it works, how to analyze it?
First, you must start from the following premise: even if technically possible, we do not calculate this ratio for a trading company without profit or with a negative result per shares ratio. In general, most analysts considered that a PE below 15 means that the stock is rather cheap. It is therefore interesting to analyse it further.
Conversely, if your PE is greater than 26, it may be time for you to take your profits, because the stock might be overpriced and soon the market will readjust to its real value. Have a look at the table below:
However, many other criteria can alter a reading of this ratio. We are only talking about one here, only. This is important to know, otherwise, you run the risk of misinterpretation of Price Earning Ratio. And a mistake in the reading of the real value of a trading company.
The limits of the ratio
If you decide to study this ratio before investing, don’t forget that the PER does not take into account the indebtedness of the trading company or its cash flow. These are very important elements in the fundamental analysis, don’t forget them.
Also, take note that, when calculating the PER, it’s result is based solely on net income. This means many other elements can distort the interpretation of the net result: exceptional profits added to the company’s balance sheet or provisions for depreciation that can be grafted as profits. Other non-quantitative elements can like goodwill, mergers and acquisitions, competitors’ moves can surface from a simple SWOT analysis. In this case, the more information, the better.
In conclusion, when we want to trade stocks from a trading company, it is better to ensure a maximum of criteria in our analysis, including those concerning the company’s core business.
For more information, send an e-mail to one of Tradeo’s representatives and he’ll be happy to help you!