Defining Price Ratio Analysis and Its Importance To Companies ⚖️
The direct relationship between market prices of a company’s shares and its earnings is what is known as a price ratio analysis or price to earnings ratio. This is a valuable concept for both investors and businesses alike that helps determine the relative values of shares. In this article, we’ll do a brief overview of what it means. We’ll also be taking a look at the telecommunication industry as a case study example.
Price Ratio Analysis – Importance and Definition
Price ratio analysis or price-to-earnings ratio (P/E ratio) is a way to value or measure a company’s share price. This is relative to its per-share earnings. P/E ratios are also known as price multiples or earnings multiple.
These ratios are what analysts use to determine the relative values of company shares. It’s also one of the most important stock analysis tools that investors use to define stock valuation versus what a company earns. In other words, this tells investors the dollar value they need to invest in order to earn one dollar from company profits.
A high P/E ratio means investors expect to earn more in the future. A lower P/E might mean investors will earn less or that the company is undervalued. It can also indicate that it’s doing historically better than previous years. If a company doesn’t earn anything or is posting losses, the price ratio is expressed as N/A or not applicable.
The median of a company’s P/E ratio over several years can be seen as a benchmark for their performance, indicating whether or not the company is worth investing in or if a stock is worth buying.
As with anything, price ratio analysis has its limitations, and one metric cannot be used to determine whether or not a company is worth investing in. Using P/E ratios to compare companies in different sectors to each other can prove faulty, as companies become profitable at different times. Price ratios are best used as one form of reference among others when comparing companies in the same sector. Market trends differ too much between different industries for this ratio to be valuable across industries. Debt and leverage might also skew insights from P/E ratios.
Price Ratio Analysis in The Telecom Industry
The telecom sector is a good example of where evaluating P/E ratios can be beneficial. Telecom companies are high in growth, and P/E ratios indicate their growth potential. Though COVID-19 has given all industries problems, the telecom industry is not doing as bad.
Australian owned and operated Central Telecoms has doubled the size of its customer base and increased its number of employees in 2020. They have plans to open up 40 new locations in the next two years. The company also received numerous awards for growth and ratings this year.
We’re seeing the same trends all around the world. Reports of telecom industries in Poland show rebounds in the last quarter of 2020 and projects numbers will return to pre-pandemic projections in 2021. Telecommunication companies have taken defensive measures during the pandemic, and they expect positive impacts to outweigh negative ones.
These are some examples of changes the industry is seeing due to the pandemic:
Negative Effect of The Pandemic on Telecom Companies
- Loss of revenue from international roaming due to travel restrictions and border closures.
- Loss of migrant workers causing a reduction in customer numbers
- Disruption of operations and maintenance due to health restrictions and lockdowns
- Reduced investments due to global financial uncertainty and supply chain disruptions
Positive Effect of The Pandemic on Telecom Companies
- Higher usage of mobile data due to increased purchases from individuals. This will cause increases in revenues for operators and services provided by smartphones.
- Remote work or work-from-home increases the need for company SIM cards, mitigating negative losses from other areas.
- Higher volumes of social and business phone calls in mobile or fixed-line networks due to virtual meetings replacing in-person interactions.
- Increased call minutes due to lockdowns and quarantines preventing social interaction.
- Projected demand increases for value-added services.
- Increased demand for private VPN networks.
Telecom P/E Ratios – Are Low Ratios Bad?
Accelerated online presence and digital transformations are happening across most industries. This is an expected effect of travel restrictions, lockdowns, and remote working. Behavioural shifts toward e-commerce are also having an effect on how businesses operate. Both aspects create a surge in demand for telecom services.
Negative impacts and disruptions persist despite numerous positive effects. Communication Systems (JCS) and Wireless Telecom Group’s P/E ratio falls at zero this May 2021. This calls for telecom companies to step up and respond to demand and new opportunities created by the pandemic. Boosts may be short-term and companies need to turn them into long-term growth.
Low-zero P/E ratios don’t always mean a company is doing bad, however. Stocks may be at bargain prices compared to previous numbers. Tesla is a good example of a company with a low or zero P/E ratio since they pour their cash flow into massive expansions. This number is also in contrast to previous years where they’ve done better, in comparison to the slow year brought on by the pandemic.
The takeaway from this is that using price ratios to analyse a company’s profitability can be very useful and insightful if done well. Otherwise, there are many limitations and other factors you’ll want to consider to ensure you’re getting the full picture of how well a company is doing. P/E ratios are helpful for sectors like telecoms, but may not be the best metric to look at for disruptor companies like Tesla. Nonetheless, it’s an important tool to understand in order to navigate the stock market or for analyzing companies within a given sector or industry.
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