Dec 12, 2008
FirstCaribbean revenue, profit diminished
FirstCaribbean Inter-national Bank Limited (FCIB) is expected to report year-end profits that have fallen off by US$80 million or 31 per cent when its earnings report becomes available.
[ more . . . ]

Dec 10, 2008
Global crisis hits Agostini’s rights issue
Agostini’s Ltd has suffered a shortfall in its rights issue which closed on October 22, 2008.
[ more . . . ]

Dec 08, 2008
BSE not fearful of crisis
THE Barbados Stock Exchange (BSE) does not foresee any major impact on its operations as a result of the global financial crisis
[ more . . . ]

Dec 08, 2008
FirstCaribbean affected by global financial crisis
THE current global financial condition has significantly impacted the net income of one the largest banks in the Caribbean.
[ more . . . ]

<< Opinions and Analysis

A Low Share Price Is Not Always Cheap

April 8, 2004

Investors have now experienced the first full round of “earnings season” since the stock market rally began last year. Of the 31 companies listed on the 1 st Tier Market 18 of them have a December 31 st year end. In accordance with the regulatory requirements most of these companies have recently published their audited financial statements. Those that have not are expected to do so shortly.

One now has the opportunity to stand back from the proponents of hype or the prophets of doom and look objectively at the respective company’s performance especially as it relates to their share price. Of the many methods used to relate a company’s performance to a company’s share price, the most popular is the price to earnings (P/E) ratio.

The P/E ratio is calculated by dividing the market price per share by the earnings per share (EPS). There can be many variants to this ratio depending on how the respective variables are defined.

• Price can usually represent the current share price or the average price over a twelve month period.
• Earnings per share can be represented by the earnings over the past twelve months (running P/E) or the forecasted earnings (estimated P/E).

Most people use the P/E ratio because of its simplicity and also because it allows you to compare like with like. The price per share is divided by the earnings per share thus allowing companies of differing sizes and with differing numbers of shares in issue to be compared. As a result the P/E ratio makes it possible to compare First Caribbean International Bank (FCIB) which has an issued share capital of 1,521,936,608 shares to Republic Bank Limited which has an issued share capital of 159,032,318 shares.

It is important for an investor to understand how the relationship between the share price and the number of shares in issue affects the value attached to a share. At the basic level the P/E ratio tells us how much an investor is willing to pay per dollar of earnings. For this reason it's also referred to as a "multiple".

Absolute Value and Relative Value

If we were to examine FCIB with a P/E multiple of 29.9 it suggests that investors in the share are willing to pay $29.90 now for every $1 of earnings that the company currently generates. It seems odd to basically exchange $29.90 for $1 but the $29.90 paid now is really in anticipation of future earnings. A rational investor would only pay this amount if he believes that over time he will receive a cash return which exceeds the amount he is currently required to pay. The higher the P/E multiple the higher the expected return. Thus even though this share is currently trading at a relatively low share price of $8.70 it is rather quite “expensive” from the perspective that the shareholder has to receive a return of $29.90 per share in future earnings over his investment horizon.

The above describes an assessment of the absolute value of a share. Relative valuation on the other hand occurs when you compare what you are required to pay now for a share against an alternative share price. Take for example other companies within the Banking Sector. RBTT, RBL and Scotiabank enjoy P/E multiples of 21.67, 18.19 and 17.73 respectively . These companies trade at a price higher than that of FCIB. However from the perspective of the P/E multiple they are all “cheaper” relative to FCIB since the expected return in relation to the price paid now is lower for these companies when compared to FCIB.

General Rules

As an investor you would evaluate the respective P/E multiples to determine whether the share provides you with adequate value. The following rules should be applied in assessing the P/E multiple, all other things being equal:

• Higher growth firms will have higher P/E ratios than lower growth firms. If projected growth rates don't justify the P/E, then a stock might be overpriced. To ascertain this all you have to do is calculate the P/E using a projected EPS.
• Higher risk firms will have lower P/E ratios than lower risk firms.
• Firms with lower reinvestment needs will have higher P/E ratios than firms with higher reinvestment rates.

The above analysis might satisfy the needs of providing a simplifying explanation but in reality it is impossible to view one variable while holding the others equal. It should be obvious to even the most casual investor that high growth firms, tend to have higher risk and high reinvestment rates.

A further caveat in using the P/E multiple is that it is only useful to compare companies if they are in the same industry. For example, the financial services sector on the TTSE has historically grown at a higher rate than the manufacturing sector and their P/Es should reflect that. As a result it would be useless to compare the P/E multiple of Republic Bank to say TCL to determine if one company’s share should be brought in preference to the other.

The use of the P/E multiple is an important tool in determining both the absolute value of a company’s share and also the value of that company’s share relative to other companies within the same sector. An investor should therefore give careful consideration to the P/E ratio prior to making investment decisions. The accompanying table indicates among other things the running EPS and P/E ratios for companies listed on the Trinidad and Tobago Stock Exchange (TTSE). The Sunday Guardian publishes this information every week on behalf of West Indies Stockbrokers Limited. You are advised to use this information in making your investment decisions.

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