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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Logistec Corporation's (TSE:LGT.B) P/E ratio and reflect on what it tells us about the company's share price. Logistec has a price to earnings ratio of 28.78, based on the last twelve months. In other words, at today's prices, investors are paying CA$28.78 for every CA$1 in prior year profit.
View our latest analysis for Logistec
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Logistec:
P/E of 28.78 = CA$42.3 ÷ CA$1.47 (Based on the year to March 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. 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.'
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.
Logistec saw earnings per share decrease by 6.7% last year. And it has shrunk its earnings per share by 8.8% per year over the last five years. So we might expect a relatively low P/E.
Does Logistec 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. You can see in the image below that the average P/E (28.8) for companies in the infrastructure industry is roughly the same as Logistec's P/E.
Logistec'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 inform my view byby checking management tenure and remuneration, among other things.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.