In This Article:
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 Prudential plc’s (LON:PRU) P/E ratio to inform your assessment of the investment opportunity. Prudential has a P/E ratio of 13.89, based on the last twelve months. That corresponds to an earnings yield of approximately 7.2%.
View our latest analysis for Prudential
How Do I Calculate Prudential’s Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Prudential:
P/E of 13.89 = £16.24 ÷ £1.17 (Based on the trailing twelve months to December 2018.)
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 a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Notably, Prudential grew EPS by a whopping 26% in the last year. And it has bolstered its earnings per share by 6.0% per year over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.
How Does Prudential’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (14.8) for companies in the insurance industry is roughly the same as Prudential’s P/E.
Prudential’s P/E tells us that market participants think its prospects are roughly in line with its industry. The company could surprise by performing better than average, in the future. I inform my view byby checking management tenure and remuneration, among other things.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. 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.