The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at DS Smith Plc's (LON:SMDS) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, DS Smith has a P/E ratio of 15.89. That means that at current prices, buyers pay £15.89 for every £1 in trailing yearly profits.
See our latest analysis for DS Smith
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 DS Smith:
P/E of 15.89 = £3.14 ÷ £0.20 (Based on the trailing twelve months to April 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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 Does DS Smith'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. If you look at the image below, you can see DS Smith has a lower P/E than the average (19.2) in the packaging industry classification.
Its relatively low P/E ratio indicates that DS Smith shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with DS Smith, it's quite possible it could surprise on the upside. 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
DS Smith shrunk earnings per share by 13% over the last year. But EPS is up 5.2% over the last 5 years.
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. Thus, the metric does not reflect cash or debt held by the company. 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.