The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use Stock Spirits Group PLC’s (LON:STCK) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Stock Spirits Group’s P/E ratio is 18.57. That is equivalent to an earnings yield of about 5.4%.
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How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Stock Spirits Group:
P/E of 18.57 = €2.4 (Note: this is the share price in the reporting currency, namely, EUR ) ÷ €0.13 (Based on the year to September 2018.)
Is A High P/E 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
When earnings fall, the ‘E’ decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Most would be impressed by Stock Spirits Group earnings growth of 20% in the last year. Unfortunately, earnings per share are down 3.3% a year, over 5 years.
How Does Stock Spirits Group’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see Stock Spirits Group has a lower P/E than the average (23.2) in the beverage industry classification.
Stock Spirits Group’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. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
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. 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.