Shareholder Blog

		When to 'PE' and when not to 'PE'!!.
		17 August 2012 \| Les Smith \| 4:31 pm	0

		The Shareholder in Stocks

I recently received a query from Tim: 'Why didn't I include reference to PE for Thorn Group (TGA) in my July 'Stock of the month' report?'. A good question. Generally, I am at odds with analysts and commentators who rely on the PE ratio. Hence I simply do forget to include it at times in my reports.

Institutional analysts and commentators tend to rely heavily on the relative PE ratio of the market and individual stocks being reviewed. So far as the market is concerned, I keep the average PE at the back of my mind at most times and I would certainly start to look for a major retraction if and when markets get close to a PE of 'twenty times'. Why?. History tells me so.

With individual stocks, some say a high PE evidences strong expectations of consistent earnings growth.

By way of example, Woolworths commands a premium as a stock demonstrating strong earnings growth - hence less risk; as does Adelaide Brighton (ABC) which is the subject of this week's 3D report.

For stocks with lower PE's (<10) they are seen as offering better value, with higher risk. I tend to view the latter from both perspectives but certainly with a greater degree of caution - meaning close examination. I do tend to make a mental note of the comparative PE of individual stocks and the market PE.

What is the 'PE' ratio. I would explain it as follows:

PE = market value per share

earnings per share (EPS)

The principal reason why I am sceptical about the PE ratio is that the market value per share

('share price') is the only true number in the equation - it results from open competition, is

transparent and cannot be disputed.

On the other hand, the denominator 'earnings per share' appearing in a company's financial

statements is really an 'accounting' measure which is open to manipulation (not suggesting

illegally) -v- the underlying earnings in cash. Plus, the EPS is calculated as at the end of the

last financial reporting date which can be out of date.

So taking a line through the reported FY12 results for Thorn Group (TGA) for its financial year ended 31 March 2012, EPS was stated to be 19.24cps and yesterday's closing share price was $.160. Therefore, I would calculate the 'current' PE for TGA as $1.60 / 0.1924c = 8.31. This compares with a sector

and market PE of 12.6, respectively.