The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at PCI Limited’s (SGX:P19) P/E ratio and reflect on what it tells us about the company’s share price. PCI has a price to earnings ratio of 8.75, based on the last twelve months. That corresponds to an earnings yield of approximately 11%.
Check out our latest analysis for PCI
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for PCI:
P/E of 8.75 = $0.77 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.087 (Based on the trailing twelve months to September 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each SGD1 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
It’s nice to see that PCI grew EPS by a stonking 30% in the last year. And it has bolstered its earnings per share by 18% per year over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.
How Does PCI’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that PCI has a lower P/E than the average (11.6) P/E for companies in the electronic industry.
This suggests that market participants think PCI will underperform other companies in its industry. Since the market seems unimpressed with PCI, 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.
Remember: P/E Ratios Don’t Consider The Balance Sheet
The ‘Price’ in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. 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).