If someone asks us about which stock is cheaper, A or B, each priced at Rp 2,700 and Rp 600, what would be the correct answer? And more importantly, how do we answer the question in without wasting too much time?

As we have discussed before in the previous Education for today article, in order to determine whether the valuation of a particular stock is cheap or expensive in short time, we can use the Price Earning Ratio(P/E) as a standard. Consequently, we cannot directly say that B is cheaper as its price is below that of A.

We can determine the P/E after we obtain the prices of two stocks by calculating the net profit of those two issuers. We can use the net profit of the previous year, that is, the year 2001, or the profit estimation of the current year 2002. However, since we have to take the prospect of the company into consideration, not its historical performances, in assessing a stock, it would be fairer if we use profit estimation of the current year. We can use the estimation of stock analysts for our convenience.

After we get the profit estimation of the current year, we divide the figure with the number of outstanding shares in order to obtain the earning per share (EPS). In this case, for example, we get the estimation of A and B of each Rp 188 and Rp 18,4 for the year 2002.

Moreover, in order to determine the P/E value we divide the current stock price with the EPS estimation. As a result, we get P/E for A and B of each 14.4x and 32.6x. It means that, according to the P/E valuation, B is cheaper than A!

Hence we can conclude that we must be cautious in deciding whether a stock is cheap or expensive. Do not be deceived by its market price, because lower price does not mean cheaper one. We also must remember that P/E ratio can only be used to compare stocks in the same industry. If in the above example we use fishery stocks then we should not compare them with cement or retail shares, since the comparison would mean nothing. Good luck!

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