The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use 1300SMILES Limited’s (ASX:ONT) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, 1300SMILES’s P/E ratio is 20.01. That is equivalent to an earnings yield of about 5.0%.

See our latest analysis for 1300SMILES

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for 1300SMILES:

P/E of 20.01 = A$6.45 ÷ A$0.32 (Based on the year to June 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each A$1 of company earnings. 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.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

1300SMILES increased earnings per share by 5.0% last year. And its annual EPS growth rate over 5 years is 7.9%.

How Does 1300SMILES’s P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, 1300SMILES has a higher P/E than the average company (16.6) in the healthcare industry.

Its relatively high P/E ratio indicates that 1300SMILES shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

Is Debt Impacting 1300SMILES’s P/E?

The extra options and safety that comes with 1300SMILES’s AU$344k net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Verdict On 1300SMILES’s P/E Ratio

1300SMILES trades on a P/E ratio of 20, which is above the AU market average of 14.7. Earnings improved over the last year. And the net cash position provides the company with multiple options. The high P/E suggests the market thinks further growth will come.

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

Of course you might be able to find a better stock than 1300SMILES. So you may wish to see this free collection of other companies that have grown earnings strongly.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.