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5.1 The Price-Earnings Ratio
Finally, we have the "P-E ratio", or price-earnings ratio, which represents a key figure in judging the value of a stock. The price-earnings ratio—also referred to as the "price-earnings multiple", or sometimes simply as the "multiple"—is the ratio of the price of a stock to the earnings per share behind the stock.
This concept is important. In simplest terms (and without taking possible complicating factors into account), "earnings per share" of a company are calculated by taking the company's net profits for the year, and dividing by the number of shares outstanding. The result is, in a very real sense, what each share earned in the business for the year — not to be confused with the dividends that the company may or may not have paid out. The board of directors of the company may decide to plow the earnings back into the business, or to pay them out to shareholders as dividends, or (more likely) a combination of both; but in any case, it is the earnings that are usually considered as the key measure of the company's success and the value of the stock.
The price-earnings ratio tells you a great deal about how investors view a stock. Investors will bid a stock price up to a higher multiple if a company's earnings are expected to grow rapidly in the future. The multiple may look too high in relation to current earnings, but not in relation to expected future earnings. On the other hand, if a company's future looks uninteresting, and earnings are not expected to grow substantially, the market price will decline to a point where the multiple is low.
Multiples also change with the broad cycles of the stock market, as investors become willing to pay more or less for certain values and potentials. Between 1966 and 1972, a period of enthusiasm and speculation, the average multiple was usually 15 or higher. In the late 1970s, when investors were generally cautious and skeptical, the average multiple was below 10. However, note that these figures refer to average multiples–whatever the average multiple is at any given time, the multiples on individual stocks will range above and below it.
Now we can return to the table. The P-E ratio for each stock is based on the latest price of the stock and on earnings for the latest reported 12 months. The multiples, as you can see, were 12 for Con Edison, 17 for GE, and 10 for Mobil. In January 1987, the average multiple for all stocks was very roughly around 15. Con Edison is viewed by investors as a relatively good-quality utility company, but one that by the nature if its business cannot grow much more rapidly that the economy as a whole. GE, on the other hand, is generally given a premium rating as a company that is expected to outpace the economy.
You can't buy a stock on the P-E ratio alone, but the ratio tells you much that is useful. For stocks where no P-E ratio is shown, it often means that the company showed a loss for the latest 12 months, and that no P-E ratio can be calculated. Somewhere near the main NYSE table, you'll find a few small tables that also relate to the day's NYSE-Composite trading. There's the table showing the 15 stocks that traded the greatest number of shares for the day (the "most active" list), a table of the stocks that showed the greatest percentage of gains or declines (low-priced stocks generally predominate here); and one showing stocks that made new price highs or lows relative to the latest 52 weeks.
You'll find a large table of "American Stock Exchange Composite Transactions", which does for stocks listed on the AMEX just what the NYSE-Composite table does for NYSE-listed stocks. There are smaller tables covering the Pacific Stock Exchange, Boston Exchange, and other regional exchanges.
The tables showing over-the-counter stock trading are generally divided into two or three sections. For the major over-the-counter stocks covered by the NASDAQ quotation and reporting system, actual sales for the day are reported and tabulated just as for stocks on the NYSE and AMEX. For less active over-the-counter stocks, the paper lists only "bid" and "asked" prices, as reported by dealers to the NASD.
It is worth becoming familiar with the daily table of prices of U.S. Treasury and agency securities. The Treasury issues are shown not only in terms of price, but in terms of the yield represented by the current price. This is the simplest way to get a bird's-eye view of the current interest rate situation—you can see at a glance the current rates on long-term Treasury bonds, intermediate-term notes, and short-term bills.
Elsewhere in the paper you will also find a large table showing prices of corporate bonds traded on the NYSE, and a small table of selected tax-exempt bonds (traded OTC). But unless you have a specific interest in any of these issues, the table of Treasury prices is the best way to follow the bond market.
There are other tables listed. These are generally for more experienced investors and those interested in taking higher risks. For example, there are tables showing the trading on several different exchanges in listed options—primarily options to buy or sell common stocks (call options and put options). There are futures prices— commodity futures and also interest rate futures, foreign currency futures, and stock index futures. There are also options relating to interest rates and options relating to the stock index futures.
6. EUROPEAN STOCKMARKETS–GENERAL TREND
Competition among Europe’s securities exchanges is fierce. Yet most investors and companies would prefer fewer, bigger markets. If the exchanges do not get together to provide them, electronic usurpers will.
How many stock exchanges does a Europe with a single capital market need? Nobody knows. But a part-answer is clear: fewer than it has today. America has eight stock exchanges, and seven futures and options exchanges. Of these only the New York Stock Exchange, the American Stock Exchange, NASDAQ (the over-the-counter market), and the two Chicago futures exchanges have substantial turnover and nationwide pretensions.
The 12 member countries of the European Community (EC), in contrast, boast 32 stock exchanges and 23 futures and options exchanges. Of these, the market in London, Frankfurt, Paris, Amsterdam, Milan and Madrid–at least–aspire to significant roles on the European and world stages. And the number of exchanges is growing. Recent arrivals include exchanges in Italy and Spain. In eastern Germany, Leipzig wants to reopen the stock exchange that was closed in 1945.
Admittedly, the EC is not as integrated as the United States. Most intermediaries, investors and companies are still national rather than pan-European in character. So is the job of regulating securities markets; there is no European equivalent of America’s Securities and Exchange Commission (SEC). Taxes, company law and accounting practices vary widely. Several regulatory barriers to cross-border investment, for instance by pension funds, remain in place. Recent turmoil in Europe’s exchange rate mechanics has reminded cross0border investors about currency risk. Despite the Maastricht treaty, talk of a common currency is little more than that
Yet the local loyalties that sustain so many European exchanges look increasingly out-of-date. Countries that once had regional stock exchanges have seen them merged into one. A single European market for financial services is on its way. The EC's investment services directive, which should come into force in 1996, will permit cross-border stockbroking without the need to set up local subsidiaries. Jean-Francois Theodore, chairman of the Paris Bourse, says this will lead to another European Big Bang. And finance is the multinational business par excellence: electronics and the end of most capital controls mean that securities traders roam not just Europe but the globe in search of the best returns.
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