This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at CMC Markets Plc's (LON:CMCX) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, CMC Markets's P/E ratio is 18.70. In other words, at today's prices, investors are paying £18.70 for every £1 in prior year profit.

See our latest analysis for CMC Markets

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for CMC Markets:

P/E of 18.70 = GBP1.66 ÷ GBP0.09 (Based on the year to September 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each GBP1 the company has earned over the last year. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price'.

Does CMC Markets Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that CMC Markets has a lower P/E than the average (21.2) P/E for companies in the capital markets industry.

CMC Markets's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

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. Then, a higher P/E might scare off shareholders, pushing the share price down.

CMC Markets saw earnings per share decrease by 21% last year. And over the longer term (5 years) earnings per share have decreased 6.5% annually. This could justify a pessimistic P/E.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

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.