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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 show how you can use Sinch AB (publ)'s (STO:SINCH) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Sinch has a P/E ratio of 30.55. That is equivalent to an earnings yield of about 3.3%.
See our latest analysis for Sinch
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Sinch:
P/E of 30.55 = SEK144.00 ÷ SEK4.71 (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 isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
Does Sinch Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. If you look at the image below, you can see Sinch has a lower P/E than the average (37.4) in the software industry classification.
Sinch'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. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
In the last year, Sinch grew EPS like Taylor Swift grew her fan base back in 2010; the 80% gain was both fast and well deserved. The sweetener is that the annual five year growth rate of 34% is also impressive. So I'd be surprised if the P/E ratio was not above average.
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. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.