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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 Delegat Group Limited's (NZSE:DGL) P/E ratio could help you assess the value on offer. Based on the last twelve months, Delegat Group's P/E ratio is 22.54. That is equivalent to an earnings yield of about 4.4%.

View our latest analysis for Delegat Group

How Do You Calculate A P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Delegat Group:

P/E of 22.54 = NZ$11.75 ÷ NZ$0.52 (Based on the trailing twelve months to December 2018.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Delegat Group increased earnings per share by a whopping 29% last year. And it has bolstered its earnings per share by 5.8% per year over the last five years. With that performance, I would expect it to have an above average P/E ratio.

Does Delegat Group Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (24.9) for companies in the beverage industry is higher than Delegat Group's P/E.

This suggests that market participants think Delegat Group 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.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.