In This Article:
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 Multi-Chem Limited's (SGX:AWZ) P/E ratio could help you assess the value on offer. Multi-Chem has a P/E ratio of 9.66, based on the last twelve months. That is equivalent to an earnings yield of about 10.4%.
View our latest analysis for Multi-Chem
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 Multi-Chem:
P/E of 9.66 = SGD0.84 ÷ SGD0.09 (Based on the trailing twelve months to December 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each SGD1 of company 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 Multi-Chem's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Multi-Chem has a lower P/E than the average (12.1) in the electronic industry classification.
This suggests that market participants think Multi-Chem will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. 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
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Multi-Chem increased earnings per share by a whopping 41% last year. And its annual EPS growth rate over 5 years is 10%. So we'd generally expect it to have a relatively high P/E ratio. In contrast, EPS has decreased by 7.0%, annually, over 3 years.
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.
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.