This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Close Brothers Group plc's (LON:CBG) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Close Brothers Group's P/E ratio is 12.17. That is equivalent to an earnings yield of about 8.2%.

View our latest analysis for Close Brothers Group

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Close Brothers Group:

P/E of 12.17 = £16.25 ÷ £1.33 (Based on the year to July 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

Does Close Brothers Group Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Close Brothers Group has a lower P/E than the average (20.9) P/E for companies in the capital markets industry.

Close Brothers Group's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Close Brothers Group, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

Probably the most important factor in determining what P/E a company trades on is the earnings growth. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Close Brothers Group's earnings per share fell by 2.0% in the last twelve months. But EPS is up 6.3% over the last 5 years.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).