The difficulty in getting to know how to start investing in the stock market has become a burden to many young investors. Truth be told, the stock market has made so much money for investors than any other investment in Ghana. Using basic financial ratios will be a great start to invest in the stock market.

In todays write up, we will focus on an investment ration known as the P/E ratio(Price to earnings ratio)

if you are new to stocks, consider reading our article on how to Buy Stocks in Ghana

Using the P/E ratio is one of the best ways to finding value stocks. The idea of value investing is putting money into companies where the price of the stock is less than or equal to the value of the stock **(P < = V).**

**P/E of > 1 means the stock is a growth stock**

**P/E of < 1 means the stock is value stock**

The greatest investor of our time Warren Buffet has made millions through value investing.

One of the most confusing statements is that of price and value. In investing in stocks, price = cost and value = worth. Most often the average investor does not know what price and value actually mean, hence making a lot of mistakes moving forward.

Cost (price) of the individual stock, is what we see displayed on the Ghana stock exchange.

Finding the price of the stock is easy, there is no need to worry so much about how to calculate it since is it available on the web or newspapers. However, determining the value of the stock is what you can’t find in the open displayed on newspapers or screens. As mentioned earlier, value is actually what the stock is actually worth. This is because value can be calculated in different ways. Thus, the value will differ based on the criteria used by an analyst to determine the worth of a stock.

In real terms, because price and value are two different concepts, if the price is greater than the value (P > V) we say the stock is **overpriced**. On the other hand, if the price is less than the value (P < V), we say the stock is **underpriced**. As an investor, which will you go for? Well, it’s obvious you will like to pay less than how much it is worth. Thus, when the price < value, it is a good investment.

In the market, investors often use some of these terms.

**Average/fairly priced**: Price of the stock is equal to the value of the stock. Price = Value

**Overprice/overvalued**: The price of the stock is greater than the value of that stock. Price > Value

Most often, this happens when investors tend to hype a particular stock. Basically, investors believe here that they will make more money in the future than they are making now.

**Underpriced/undervalued**: The price is less than the value of that stock. This is just the exact opposite of overpriced stocks. Thus, investors believe that the company will perform worse than it is currently doing, hence no need to pay so much for a loss in the future.

An intelligent investor will have to determine what an investment is actually worth. And then compare the current trading price of that stock to the value of the stock calculated. In doing so, the investor gets to know if the company stocks are fairly priced/underpriced or overpriced. This will help us to determine if it is a good investment or not.

The value of a stock can be determined through its earnings (profit). The company that does not make profit is basically not having value. It is easier to determine the value of a profitable business than an unprofitable one.

In valuing a company, I mentioned earnings. What then do we mean by earnings?

Earnings is the operating profit of a company at the end of its accounting year (one year). In Ghana, the period starts from January and ends in December. But as a requirement for all companies listed, they publish their unaudited financial statement every 3 months. Thus, every quarter. The earnings help to measure how profitable the company is in the past 12 months.

It is a known fact that stocks are shares of a company, and by owning a share, it means you are a part owner of that company. This also means that you are also a partial owner of the company’s profits.

The P/E ratio is the price to earnings ratio. Now it should be noted that the earnings will not be the total profit for the company but rather that portion of the profit that an investor gets. Example. If a company has 10,000 shareholders and the profit is 10,000 for the year, the earnings will be 1. Thus 10,000/10,000 = 1(thus earnings per share, for every share you own, how much profit is attributable)

Let’s say on the stock exchange, this company’s share price is trading at GHs 10 per share.

In finding the P/E ratio, which is the price /earnings. Thus, 10/1 = 10. Thus, the P/E ratio of these company is 10.

Now let’s define the P/E ratio mentioned above.

P/E less than 10, is considered underpriced, good value investment

P/E ratio of 15 is considered a fairly priced investment. This is still a good buy for a value investor.

P/E ratio of more than 20 is considered and overpriced investment and a typical value investor will not buy this stock.

Most often, some analyst and finance professionals do some analysis and publish the P/E ratios of these companies.

Now it should be noted that if a company’s share is trading at say 5 cedis and earnings is 20 pesewas, it means that you are paying 5 cedis to enjoy a profit of 20 pesewas which will give you a P/E of 25 (5/0.20).

The P/E ratio is a simple way to look at investing in the stock market, but before investing, there is also the need to consider other factors which include dividend, debt, and price to book value, market share and growth potential, competitive advantage among others.

**By:** Kenneth-Shine Adu

kennethadu550@gmail.com

0248556177