PE Ratios & Profit Performance Essay Example | Topics and Well Written Essays - 1750 words

PE Ratios & arrive at Performance - Essay ExampleAs said by Flamholtz (1986, p655), The price-earnings (P-E) dimension measures the relationship of the foodstuff price of a firms common stock to its earnings per sh atomic number 18, the P/E ratio is a measure of analysing a companys market position and investors commit that is reflected in the market price of its shares. The higher the price-earnings ratio, the higher the growth potential the company has in the view of its investors. It reveals the market worth of a companys shares and explains how expensive the shares are in relation to the earnings obtained on the shares. For instance, two different companies have the akin level of net profit but one company has a lower Price-earnings ratio, it would reflect that its shares are cheaper than the other company.From the above chart also, the P/E ratios of five companies can easily be spotted. All these companies are from the same industry and are among the most popular companies in the retail sector. As reflected by above price-earning ratios, these companies have a varying range of ratios as at February 8, 2006. The price-earning ratio is calculated by dividing a companys market price with the earnings per share and therefore, the price-earning ratio of a company depends upon several factors that are responsible to continue it at a lower or higher level. The determinants of a companys P/E ratio force the companys market price to fluctuate, which is followed by a wavering in the ratio. Some of the major determinants causing variation in different companies price-earnings ratios are discussed belowGrowth PotentialBrealey and Meyers (1984) suggest that a companys high price-earning ratio reflects that the investors have to a greater extent confidence in the companys future growth potential. It shows that the expectation of a companys future growth also has a great impact on its price-earning ratio. It is true that investors do have a keen eye on various comp anies financial position and deed so that they can also return with a company who is climbing the high ladders of growth and profitability. If the company is growing, it will have more profit to be forwarded to the shareholders. Therefore when the investors believe in a companys future performance, they will be willing to invest more in the companys shares leading to a significant rise in the stock value followed by an increase in the P/E ratio.The chart displaying the price-earning ratios of the companies from same industry reveals that the company with a high P/E ratio i.e., Morrison plc with a P/E ratio of 47.2, has more future growth prospects in the eyes of its investors and shareholders than the other companies in the industry i.e., Boots, Tesco, Marks and Spencer and JB Sports plc. This is because the investors mostly look for benchmarking a companys performance and potential with the other companies in industry standing at the same level and once they find a company with b etter prospects, they invest more of their funds in the companys shares. Hence, it can be said that the element of growth potential is one of the major causes underlying the differences between the above companies price-earning ratios.Net ProfitSmith and Skousen (1987) suggest that an increase or decrease in a companys price-earning ratio is the resultant of its profitability. It indicates that more a company is profitable