From Investopedia, this definition of a company’s price to earnings ratio.
A valuation ratio of a company’s current share price compared to its per-share earnings. Calculated as:
Market Value per Share
Earnings per Share (EPS)For example, if a company is currently trading at $43 a share and earnings over the last 12 months were $1.95 per share, the P/E ratio for the stock would be 22.05 ($43/$1.95). In general, a high P/E suggests that investors are expecting higher earnings growth in the future compared to companies with a lower P/E. However, the P/E ratio doesn’t tell us the whole story by itself. It’s usually more useful to compare the P/E ratios of one company to other companies in the same industry, to the market in general or against the company’s own historical P/E. It would not be useful for investors using the P/E ratio as a basis for their investment to compare the P/E of a technology company (high P/E) to a utility company (low P/E) as each industry has much different growth prospects.
Newcrest Mining (ASX:NCM) is the one Australian mining major exposed to the greatest level of country risk with 63% of its assets situated in nation-states categorized as ‘very high-risk’ by analysts. 63% of Newcrest’s assets are situated in countries categorized as ‘very high-risk’, including Papua New Guinea, Indonesia and the Ivory Coast, compared to 14% for Rio Tinto and 1% for BHP, the later of whom’s growth assets are primarily located in OECD nations.
Bloomberg gives the price to earnings (P/E) ratio of Rio Tinto as 7.3787, BHP as 7.8675, and Newcrest Mining as 17.0909.
Considering the warning that the P/E ratio may not be a valid comparative yardstick, I searched and found these comparative numbers–BHP first followed by Newcrest Mining.
- Net Profit Margin = 33.38/23.55
- Return on Assets = 24.98/8.19
- Return on Average Equity = 44.92/9.7
P/E ratios are historical information, wheras the market tries to look forward into the future. Of greater interest to me is the forward P/E estimate and forward earnings estimates. A good example of why is RIM, where the P/E was very good up until recently, but has headed into the dumpers lately and likely into the future. RIM share price has collapsed, and an investor 18 months ago would have seen a good P/E, but would have lost big money if he had bought at that time.
When I look at companies I do a DCF on estimated forward earnings for the next 40 years. If the data is available I’ll use the past 10 years of earnings as part of my 40 years. I then take a ratio of the current price to the DCF and look for a ratio less than one…preferably less than 0.75. Take your pick on a discount rate, but I usually do a half dozen at 8% to 15%, depending on the company. Banks are lower discount rates. Mining companies would be higher.
I also look at price to book, debt level and a history of increasing revenue. Do a google on Ben Graham, for his book “The Intelligent Investor”. The original was written back in the late ’40′s but I think it’s still the best investing book ever written.
P/E’s for mining companies are problematic. For instance I have seen gold miners with 25:1 pe’s but only 8 years of ore remaining. Think about that one for a moment. Exactly how are these “investors” every planning on getting any return on this? And be assured that the company will spend every cent of cash flow trying to reinvent themselves. So there is effectively nothing for the shareholders apart from a 2% dividend. So it is the greater fool game at play which I will gladly short. The market is quite mad at times.