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 CSR Limited's (ASX:CSR) P/E ratio to inform your assessment of the investment opportunity. CSR has a P/E ratio of 14.13, based on the last twelve months. That corresponds to an earnings yield of approximately 7.1%.
Check out our latest analysis for CSR
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for CSR:
P/E of 14.13 = A$3.9 ÷ A$0.28 (Based on the year to March 2019.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'
Does CSR Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. If you look at the image below, you can see CSR has a lower P/E than the average (23.2) in the basic materials industry classification.
Its relatively low P/E ratio indicates that CSR shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with CSR, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
CSR saw earnings per share decrease by 30% last year. But it has grown its earnings per share by 9.6% per year over the last five years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.