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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Steadfast Group Limited's (ASX:SDF) P/E ratio and reflect on what it tells us about the company's share price. Steadfast Group has a price to earnings ratio of 30.35, based on the last twelve months. That corresponds to an earnings yield of approximately 3.3%.

See our latest analysis for Steadfast 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 Steadfast Group:

P/E of 30.35 = A$3.18 ÷ A$0.10 (Based on the trailing twelve months to December 2018.)

Is A High Price-to-Earnings 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

P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.

Notably, Steadfast Group grew EPS by a whopping 25% in the last year. And it has bolstered its earnings per share by 19% per year over the last five years. With that performance, I would expect it to have an above average P/E ratio.

How Does Steadfast Group's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below, Steadfast Group has a higher P/E than the average company (20.3) in the insurance industry.

That means that the market expects Steadfast Group will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors 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

Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

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.