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 Saras SpA’s (BIT:SRS) P/E ratio to inform your assessment of the investment opportunity. Saras has a P/E ratio of 5.55, based on the last twelve months. That means that at current prices, buyers pay €5.55 for every €1 in trailing yearly profits.
View our latest analysis for Saras
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Saras:
P/E of 5.55 = €1.7 ÷ €0.31 (Based on the trailing twelve months to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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
Earnings growth rates have a big influence on P/E ratios. 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. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
It’s nice to see that Saras grew EPS by a stonking 86% in the last year. And it has bolstered its earnings per share by 62% per year over the last five years. So we’d generally expect it to have a relatively high P/E ratio.
How Does Saras’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (9.9) for companies in the oil and gas industry is higher than Saras’s P/E.
Saras’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 Saras, 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.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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 taking on debt (or spending its remaining cash).
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.