In This Article:
Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Convatec Group Plc's (LON:CTEC) P/E ratio to inform your assessment of the investment opportunity. Convatec Group has a P/E ratio of 32.53, based on the last twelve months. That means that at current prices, buyers pay £32.53 for every £1 in trailing yearly profits.
Check out our latest analysis for Convatec Group
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Convatec Group:
P/E of 32.53 = USD2.68 (Note: this is the share price in the reporting currency, namely, USD ) ÷ USD0.08 (Based on the year to June 2019.)
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 Does Convatec Group's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (32.5) for companies in the medical equipment industry is roughly the same as Convatec Group's P/E.
Convatec Group's P/E tells us that market participants think its prospects are roughly in line with its industry. If the company has better than average prospects, then the market might be underestimating it. I would further inform my view by checking insider buying and selling., among other things.
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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Convatec Group shrunk earnings per share by 33% over the last year.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
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).