This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to St Barbara Limited's (ASX:SBM), to help you decide if the stock is worth further research. What is St Barbara's P/E ratio? Well, based on the last twelve months it is 7.94. That is equivalent to an earnings yield of about 13%.

See our latest analysis for St Barbara

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for St Barbara:

P/E of 7.94 = A$3.12 ÷ A$0.39 (Based on the year to December 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each A$1 of company earnings. 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. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

St Barbara saw earnings per share improve by -9.4% last year. And its annual EPS growth rate over 3 years is 22%.

How Does St Barbara's P/E Ratio Compare To Its Peers?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. We can see in the image below that the average P/E (12.6) for companies in the metals and mining industry is higher than St Barbara's P/E.

St Barbara'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 St Barbara, 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

The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. 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).

How Does St Barbara's Debt Impact Its P/E Ratio?

With net cash of AU$357m, St Barbara has a very strong balance sheet, which may be important for its business. Having said that, at 21% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Verdict On St Barbara's P/E Ratio

St Barbara trades on a P/E ratio of 7.9, which is below the AU market average of 16.1. EPS was up modestly better over the last twelve months. And the net cash position gives the company many options. So it's strange that the low P/E indicates low expectations.

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.