How to Use the P/E Ratio to Select Cheap Stocks

During market downturns, many investors look at target stocks but are unsure whether the current price is worth it, whether they should buy now, and when they will see profits. These questions can often be answered by P/E ratio คือ — a valuation tool that value investors use most frequently.

What is the P/E Ratio or Price Per Earnings Ratio?

The P/E ratio is a comparison between the stock price and earnings per share. It indicates that if an investor buys the stock at this price, how many years they need to wait to break even, assuming the company’s profit remains the same each year.

Calculation formula: P/E = Stock Price ÷ EPS (Earnings Per Share)

Main factors in the P/E Ratio formula

1. Stock Price (Price)
This is the current price at which investors buy the stock. The lower the purchase price, the lower the P/E ratio, which means a quicker return on investment.

2. Net profit per share (EPS)
Calculated from the company’s total net profit for each year divided by the number of shares outstanding. This represents the portion of profit attributable to one share annually.

Example of calculating the P/E Ratio

Suppose an investor buys a stock at 5 baht per share, and the company’s EPS is 0.5 baht:

• P/E = 5 ÷ 0.5 = 10 times
• This means the company pays a return of 0.5 baht each year
• After 10 years, the investor will have recovered the initial 5 baht investment, breaking even in the 10th year
• After the 10th year, all profits are net profit

The lower the P/E, the cheaper the stock and the faster the return on investment

Forward P/E vs Trailing P/E: Differences, Advantages, and Disadvantages

Forward P/E (Future P/E)

Uses the current stock price divided by projected future earnings.

Advantages:
Helps to see the company’s growth potential in the future. Suitable for selecting stocks with growth prospects.

Limitations:
Analyst or company forecasts may be inaccurate, and some companies might underestimate earnings to meet targets.

Trailing P/E (Past P/E)

Uses the current stock price divided by earnings per share over the past 12 months.

Advantages:
Based on actual historical data, quick to calculate, and very popular due to transparency.

Limitations:
Past performance does not guarantee future results. If the company experiences significant events that change profits, this figure may become outdated.

Limitations of the P/E Ratio that investors should know

EPS changes constantly

If a company grows rapidly, EPS may increase. For example, EPS rises from 0.5 to 1 baht, while the stock price remains at 5 baht. The P/E drops to 5 times, meaning the break-even point shortens to 5 years instead of 10.

Conversely, negative factors such as trade restrictions might cause EPS to fall to 0.25 baht, raising the P/E to 20 times. The break-even period then extends to 20 years.

P/E cannot be directly compared across different industries

Tech companies often have higher P/E ratios than retail companies because growth expectations differ.

Summary

The P/E ratio is a useful tool for assessing whether a stock is undervalued or overvalued. However, it should not be used in isolation. Investors should understand P/E ratio คือ and how to use it correctly, then combine it with other analyses such as growth potential, financial health, and other factors to make more accurate investment decisions. Success in the stock market comes from a deep understanding of various tools and using them wisely.