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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we'll show how Renew Holdings plc's (LON:RNWH) P/E ratio could help you assess the value on offer. Renew Holdings has a P/E ratio of 15.01, based on the last twelve months. That is equivalent to an earnings yield of about 6.7%.
View our latest analysis for Renew Holdings
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 Renew Holdings:
P/E of 15.01 = £4.23 ÷ £0.28 (Based on the trailing twelve months to March 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each £1 of company earnings. 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
Earnings growth rates have a big influence on P/E ratios. 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.
It's nice to see that Renew Holdings grew EPS by a stonking 46% in the last year. And earnings per share have improved by 6.6% annually, over the last five years. I'd therefore be a little surprised if its P/E ratio was not relatively high.
Does Renew Holdings Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. As you can see below, Renew Holdings has a higher P/E than the average company (9.6) in the construction industry.
That means that the market expects Renew Holdings will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.