Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Flight Centre Travel Group Limited's (ASX:FLT) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Flight Centre Travel Group has a P/E ratio of 18.15. That means that at current prices, buyers pay A$18.15 for every A$1 in trailing yearly profits.

Check out our latest analysis for Flight Centre Travel Group

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for Flight Centre Travel Group:

P/E of 18.15 = A$44.17 ÷ A$2.43 (Based on the trailing twelve months to December 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each A$1 the company has earned over the last year. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the 'E' will be lower. That means even if the current P/E is low, it will increase over time if the share price stays flat. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Flight Centre Travel Group's earnings per share fell by 4.9% in the last twelve months. And over the longer term (5 years) earnings per share have decreased 1.6% annually. So it would be surprising to see a high P/E.

Does Flight Centre Travel Group Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (18.6) for companies in the hospitality industry is roughly the same as Flight Centre Travel Group's P/E.

Flight Centre Travel Group's P/E tells us that market participants think its prospects are roughly in line with its industry. If the company has better than average prospects, then the market might be underestimating it. Checking factors such as the tenure of the board and management could help you form your own view on if that will happen.

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 spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.