PRICE-PROFIT RATE

In our previous article, we explained the market value book value ratio from market multipliers. In this article, we will talk about the price earnings ratio, which is another market multiplier.

The price / earnings ratio is a common measure of the respect investors attribute to the company. In other words, if you invest your money in a company today, after how many years will you get it back? It is the answer to the question. Let's look at how this ratio is calculated after these definitions.

The share part of the price / earnings ratio expresses the market value of the company. (market value = total number of stocks * market price) Earning in the denominator represents the net profit. From here, the price earning ratio appears as the market value / net profit. You can also calculate this ratio as follows, you can find the market price of the stock by dividing it by the profit per share. (Earnings per share = net profit / total number of stocks)

So, will we decide to buy or sell each stock by looking at this ratio? The answer to this question, as you guessed, is of course not. The price earning ratio is a ratio that is looked at in companies that post regular profits and decided in trading or long-term investments. Looking at this ratio and investing in a company that makes a profit, a loss or a continuous loss will have meaningless results. It would be more logical to invest in these types of companies by looking at the market value book value ratio. There are also various classifications within the price earning ratio. The price earning rate that will occur in the future periods is called the prospective F / K ratio, and the price earning ratio that is formed as of now is called the historical price earning ratio. There is also a growth price earning ratio. I will not explain it here. I pass the reader to investigate this.

Let's go back to our raw meatball shop. We established the Investment Çiğ Köfte A.Ş. for 300 thousand TL and at the end of the first year we had a net profit of 32 thousand TL. Meanwhile, we had offered 33.3% of our company to the public and assumed that our stock price was traded at 2 TL in the market. If you wish, let's calculate the price earning rate of our company.

Market value = TL 2 * 300,000 stocks = TL 600,000

Net profit = 32,000 TL

Price earning ratio = 600,000 / 32,000 = 18.75. Let's look at another calculation method.

Market price = 2 TL

Earnings per share = 32,000 TL / 300,000 pieces of stock = 0.1066 krş

Price earning ratio = 2 TL / 0.1066 krş = 18.75. As can be seen, it gives the same value in two proportions. We call this ratio the Historical price earning ratio. According to this definition, the investor who invests in this company today will get back all the money he put in after 18.75 years. However, in order to make this definition, the market price of our company must always remain 2 TL and our company must earn 0.1066 kurus per share every year for 18.75 years. Therefore, since this will not be the case in general, we need to calculate our company profits in the upcoming period. Let's say our raw meatball company estimates that it will make a profit of 70,000 TL next year. Then what will be our price earning rate one year from now?

Price earning ratio = 600,000 TL / 70,000 TL = 8.57. As you can see, the price earning ratio, which was 18.75 this year, actually drops to 8.57 the next year. We call this price earning ratio the prospective price earning ratio.

To predict the future profitability of companies that are important in price earning ratio. In this way, you can find the price earning rate in the coming years and decide whether the company is expensive or cheap. If the company has investment and you think it will increase its profitability in the coming periods, this rate, which seems expensive today, may actually seem cheap for the next period.

While we were defining the price earnings ratio, we said that it is a common measure of the respect investors attribute to the company. You will find that companies that make regular profits and increase their profits generally have a high price earning ratio. This high value is by definition above.

In our next article, we will talk about the market multipliers, the Price / Net sales ratio.